An investor in the 28 percent tax bracket is trying to decide which of two bonds to select: one is a 5.5 percent U. S. Treasury bond selling at par; the other is a municipal bond with a 4.25 percent coupon, which is also selling at par. Which of these two bonds should the investor select? Why?

Interest on U.S. Treasury bonds is taxed at 28%. Interest on municipal bonds is not taxed.

Do the math to figure out which is the better buy.

To determine which bond the investor should select, we need to compare the after-tax yield of each bond. We can calculate this by multiplying the pre-tax yield by (1 - tax rate).

For the U.S. Treasury bond:
Pre-tax yield: 5.5%
Tax rate: 28%
After-tax yield = 5.5% * (1 - 0.28) = 3.96%

For the municipal bond:
Pre-tax yield: 4.25%
Tax rate: 28%
After-tax yield = 4.25% * (1 - 0.28) = 3.06%

So, the after-tax yield for the U.S. Treasury bond is 3.96%, while the after-tax yield for the municipal bond is 3.06%.

The investor should select the U.S. Treasury bond because it offers a higher after-tax yield compared to the municipal bond. In this case, the difference between the two bonds is significant enough to warrant choosing the U.S. Treasury bond.

It's important to note that this analysis assumes that the investor can purchase the bonds at their par value, meaning there are no premiums or discounts. Additionally, the tax rate mentioned here is specific to the investor's 28% tax bracket.