Final answer:
To calculate the equivalent taxable yield of a municipal bond with a 6.00% coupon rate for a taxpayer in a 38% tax bracket, use the formula: Equivalent Taxable Yield = Tax-Exempt Yield / (1 - Tax Bracket). The answer is 9.68%, meaning the taxpayer would need a taxable bond with at least that yield to match the tax-exempt benefits of the municipal bond.
Step-by-step explanation:
The question you've asked is how to determine the equivalent taxable yield of a municipal bond for a taxpayer in a 38% combined tax bracket, given that the bond has a coupon rate of 6.00% and is trading at par. To find the equivalent taxable yield, you can use the formula: Equivalent Taxable Yield = Tax-Exempt Yield / (1 - Tax Bracket).
So, for your bond with a tax-exempt yield of 6.00%, the calculation for a taxpayer in the 38% tax bracket would be 6.00% / (1 - 0.38) = 6.00% / 0.62 = 9.68%. This means the investor would need to find a taxable bond with a yield of 9.68% to achieve the same after-tax income as the 6.00% tax-exempt municipal bond.
Remember, the value of a bond can fluctuate with market interest rates. If market interest rates rise, the value of existing bonds falls, as newer bonds pay higher coupon rates. Conversely, if market interest rates fall, existing bonds with higher rates become more valuable.