If you are in the 20% federal income tax bracket, what is your after-tax yield on a municipal bond that is currently trading at par to yield 5%. Assume there are no state or local taxes.

The answer is 6.25%

Explanation:

A municipal bond is tax free.

With a federal income tax bracket of 20%, the first thing is to calculate the reciprocal of the tax bracket: 20% = 0.2

= 1 - tax rate = 1 - 0.2 = 0.8

The next step is to divide the rate at which the municipal bond is trading by the reciprocal of the tax rate earlier calculated.

5/0.8 = 6.25%

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