Consider the following yields on bonds with approximately 20 years to maturity:

Issuer                                                                            Yield            Tax Status

New York City Transitional Finance Authority           3.272%         Tax Exempt Muni

State of Illinois Build America Bond (BAB)              6.691%         Taxable

State of Connecticut General Obligation (GO)            3.695%         Tax Exempt Muni

Verizon Communications (corporate bond)              5.460%         Taxable                                  

Calculate the taxable equivalent yields of the tax exempt municipal bonds for the following marginal tax rates: 10%, 15%, 28%, 35%. For which of these tax rates will an investor prefer the NYC Transitional Finance Authority bond to the State of Illinois Build American Bond? To the Verizon Communications bond? For which of these tax rates will an investor prefer the State of Connecticut bond to the State of Illinois Build America Bond? To the Verizon Communications bond?

Given your answer in part a., why would an investor ever buy the NYC Transitional Finance Authority bond rather than the Illinois BAB or the Verizon Communications bond?

What is the marginal tax rate for which an investor is indifferent between the Verizon Communications bond and the NYC Transitional Finance Authority bond? What is the marginal tax rate for which an investor is indifferent between the Verizon Communications bond and the Connecticut General Obligation bond?

A New York City investor is trying to decide between the NYC Transitional Finance Authority bond and the Connecticut General Obligation bond.   The investor is subject to a marginal federal income tax rate of 39.6%, and is subject to a 12% marginal tax rate for New York City and State income tax. Calculate the taxable equivalent yield of each bond for this investor. Everything else equal, which bond will this investor prefer?

A Connecticut investor is trying to decide between the Connecticut General Obligation bond and the New York City Transitional Finance Authority bond.   The investor is subject to a marginal federal income tax rate of 39.6%, and is subject to an 6.5% marginal tax rate for Connecticut income tax. Calculate the taxable equivalent yield of each bond for this investor. Everything else equal, which bond will this investor prefer?

Given your answers to parts d. and e., explain the attraction of municipal bonds for investors that reside in the state of issue.