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Principles of finance, a la shmoop. Comparing muni bond returns with the

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returns of taxable bonds. Alright well if you've been following the bouncing ball [Briefcase with the title written on it]

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then you know that the coupon for muni bonds is typically much lower than the

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coupon for corporate bonds of similar risk in duration and all that stuff, why? [Bouncing ball following the sentence along]

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Is there much less risk in muni as well? No not necessarily are there different

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durations in munis well no not necessarily... [The questions are crossed out on a whiteboard]

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All right hint as always the answer rhymes with shmaxes, yep muni bond

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interest is tax deductable so if you pay say 50 percent marginal federal and

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state income tax in a blue state muni bonds could pay a lot less interest than [The lights are turned off for the presentation]

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their similar risk taxable corporate bonds and you'd still be better off. That

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is if a corporate bond pays nine percent interest which is to you four and a half

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percent after tax and doubly deductible muni bonds pay five percent meaning [The different bonds and their tax rates are shown on a whiteboard]

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deductible from state and federal well you do better on a net after-tax basis

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everything else held equal with the muni bond than you would on the corporate

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bond. There's one formula that you need to know that applies here and it'll save

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you hours of grief and gallons of blood shed if you just memorize it. The catchy [Woman looking depressed]

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title, the tax equivalence of taxable and tax-free bonds it was the original title

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of Moby Dick I think yeah well maybe not... All right well the formula is as follows [Whale pops up and says no one is going to read that]

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tax-free interest rate divided by the quantity one minus the tax bracket.

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All right, let's make up an example here where the tax equivalent rate is 3% that is you're

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paying 50 percent tax on a corporate bond that yields six percent well how's

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that work? Well the tax-free interest rate is three percent meaning that a

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doubly tax-free muni bond pays three percent and you're dividing it by one

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minus your tax bracket or rather the marginal tax you pay on the last dollar [The working are shown on the whiteboard]

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you earn. If that rate is 50 percent well then the break-even price is 1 minus 0.5

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there which is in California anyway 0.5 and that number gets divided into the 3

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percent to equal 6 percent. All right we showed you all the math there

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get it got it good because don't worry Uncle Sam always get his. [Get it, got it, good, pops up quickly]

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I want you to pay taxes...

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