Final answer:
To calculate the equivalent aftertax yield, determine the aftertax interest income by subtracting taxes from the bond's interest income, then divide by the bond's price. For a bond with a 6.04% coupon rate and a 39% tax rate, the aftertax yield is approximated at 3.684%.
Step-by-step explanation:
The question asks how to calculate the equivalent aftertax yield of a taxable bond with a coupon rate and a yield to maturity (YTM). To find the aftertax yield, you'll first determine the amount of interest income that will be taxed. Then, subtract the tax owed from the interest income to find the aftertax interest income. Lastly, divide the aftertax income by the bond's price to find the aftertax yield.
For a bond with a coupon rate of 6.04%, the interest income from a $1,000 face value bond would be $60.40 annually. If the investor's marginal tax rate is 39%, they would pay $23.56 in taxes on this interest ($60.40 × 39%). The aftertax interest income is then $60.40 - $23.56 = $36.84. Finally, if we assume the bond's price aligns with its YTM of 5.67%, the price of the bond would be approximately $1,000 (since when a bond's YTM equals its coupon rate, it typically trades at par value). Therefore, the equivalent aftertax yield is $36.84 / $1,000 = 3.684%.