80 - If that taxpayer invested in municipal bonds that paid...

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Interest on corporate bonds is taxable to the recipient while interest on municipal bonds is tax-free. Would you expect that the interest rate on a corporate bond would be higher or lower than the rate on a municipal bond of comparable quality and term? Why? Answer: Assuming comparable quality and bond term, we should expect that interest rates on corporate bonds to be higher than interest rates on municipal bonds. Interest received on a corporate bond is fully taxable at rates of up to 35%. Thus, a taxpayer in the highest tax bracket who receives $1,000 in interest will pay $350 in taxes, giving him or her $650 after tax.
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Unformatted text preview: If that taxpayer invested in municipal bonds that paid the same rate of interest, the taxpayer would end up with $1,000 after tax (since the municipal bond interest is not taxed). We would expect individuals to pay more for a bond that gives them $1,000 after tax than a bond that gives them $650 after tax. Thus, the price of the municipal bonds will be bid up resulting in a lower interest rate for the municipal bond and higher interest rate for the corporate bond. Recall from your Finance class that bond prices and interest rates work in an inverse manner....
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