Julie Magnolia has $50,000 cash to invest for three years. Two types of bonds are available for consideration. She can buy a tax-exempt Arizona state bond that pays interest of 9.5% per year, or she can buy a corporate bond. Julie's marginal tax rate is 25% for both ordinary income and capital gains. Assume that any investment decision considered will not change her marginal tax bracket.(a) If Julie were looking for a corporate bond that was just as safe as the state bond, what interest rate on the corporate bond is required so that Julie would be indifferent between the two bonds? There would be no capital gains or losses at the time of her trading the bond.(b) In (a), suppose at the time of trading (year 3) that the corporate bond isexpected to be sold at a price 5% higher than its face value. What interestrate on the corporate bond is required so that Julie would be indifferentbetween the two bonds?(c) Alternatively, Julie can invest the amount in a tract of land that could be sold at $75,000 (after she pays the real-estate commission) at the end of year 3. Is this investment better than the state bond?
Julie Magnolia has $50,000 cash to invest for three years. Two types of bonds are available for consideration. She can buy a tax-exempt Arizona state bond that pays interest of 9.5% per year, or she can buy a corporate bond. Julie's marginal tax rate is 25% for both ordinary income and
(a) If Julie were looking for a corporate bond that was just as safe as the state bond, what interest rate on the corporate bond is required so that Julie would be indifferent between the two bonds? There would be no capital gains or losses at the time of her trading the bond.
(b) In (a), suppose at the time of trading (year 3) that the corporate bond is
expected to be sold at a price 5% higher than its face value. What interest
rate on the corporate bond is required so that Julie would be indifferent
between the two bonds?
(c) Alternatively, Julie can invest the amount in a tract of land that could be sold at $75,000 (after she pays the real-estate commission) at the end of year 3. Is this investment better than the state bond?
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