3. Suppose you are in the 30% federal income tax bracket and 7% state income tax bracket. You purchase a 10-year maturity bond issued by the State of Maryland and the bond coupon income is exempt from state and federal income taxes. Answer the following questions.

a. If the municipal bond yield is 4%, what is taxable bond equivalent yield? If a 10-year corporate bond with similar credit quality provides 8% yield, which bond do you prefer between the municipal bond and corporate bond? Why?

b. Suppose the municipal bond is not state income tax exempt (only federal income tax exempt). Which bond do you prefer between the municipal bond and corporate bond?