How to calculate the investor's marginal tax rate with this information...?

A 8.4% general obligation bond is issued by the state of NY and sells for a par value of $5000. If an investor can earn a yield on an IBM corporate bond of 9.88% at which point he would be indifferent between the 2 bonds, what is the investor's marginal tax rate?

It's a hw question for finance and I have no idea how to find it.

8.4 / 9.88 = 85%

1 - .85 = .15

The marginal rate is 15%

Thus, if you receive 9.88% on a taxable bond, you pay 15% of that in tax and you have 85% remaining, which is the equivalent of 8.4% yield

First it is a very poorly worded question. And, I think there is a flaw in the question. Generally a state issued bond is not taxable...even if it is a general obligation bond.

If the teacher means the bonds are equal considering taxation...then you have to calculate several things. With the mention of a par value of $5000 par value, I am making the assumption that is the amount invested.

The non-taxable state bond would yield $420 a year. And the IBM bond would pay $494 a year. Thus, for both bonds to be equal the tax on $494 has to equal $74.

And 74/494= 14.98%. And it doesn't matter if you change the investment amount...the percentage is the same. Here is the flaw...there is not a 14.98% tax rate. There is a 15% tax rate though. But, to be fair if it is $5000 invested it would only make 10 cents of difference. With rounding it wouldn't effect the tax return. But, that is an assumption I made...if it is $25,000 it does make a difference and they are no longer equal.

Now granted this approach only works if there is no other income that effects the tax rate. In other words this will rarely be the case in the real world.

I do admit that kckid2 method is simplier...it is not always going to be correct. I told you how to do it in the real world. You have to consider other income as well.

Hope this helps