Question: Tiger National Bank regularly purchases municipal bonds issued by small rural school districts in its region of the state. At the moment, the bank is considering purchasing an $8 million general obligation issue from the Youngstown school district, the only bond issue that district plans this year. The bonds, which mature in 15 years, carry a nominal annual rate of return of 7.75 percent. Tiger, which is in the top corporate tax bracket of 35 percent, must pay an average interest rate of 7.38 percent to borrow the funds needed to purchase the municipals. Would you recommend purchasing these bonds?
a. Calculate the net after-tax return on this bank-qualified municipal security. What is the tax advantage for being a qualified bond?
b. What is the tax-equivalent yield for this bank-qualified municipal security?