Question

The taxable equivalent yield for an investor in the 36% marginaltax bracket holding a 4% municipal bond is:

a)6.25%
b)5.44%
c)4.45%
d)4%
e)2.56%
Which of the following numbers

Answer 1

The taxable equivalent yield for an investor in a 36% marginal tax bracket holding a 4% municipal bond is 6.25%. This yield reflects what a taxable bond would need to return to equal the after-tax benefit of the tax-exempt municipal bond.

Step-by-step explanation:

The student is asking about the taxable equivalent yield for an investor in a 36% marginal tax bracket holding a 4% municipal bond. To determine the equivalent yield on a taxable bond, you would use the formula: Taxable Equivalent Yield = Tax-Exempt Yield / (1 - Tax Rate). Here, the tax-exempt yield is the yield on the municipal bond, which in this case is 4%, and the investor's tax rate is 36%. Therefore, applying the formula we get: Taxable Equivalent Yield = 0.04 / (1 - 0.36) = 6.25%.

It is important to understand that municipal bonds are often tax-exempt, and the yield an investor receives must be adjusted to compare it to taxable bonds. The tax equivalent yield allows an investor to see what yield they would need from a taxable bond to match the after-tax return of the tax-exempt bond.