Question

You are examining two different MMMFs. Fund A is tax-exempt and pays 5%. Fund B is taxable and pays 6%. You live in a state that imposes no income taxes and are in a 28% federal tax bracket. At what tax rate would the two funds have identical yields

Answer 1

Two Different MMMFs

The tax rate to produce identical yields is 16.67%

Step-by-step explanation:

For Fund A & B to produce identical yields:

Fund's A yield of 5% must equal Fund B's 6% (1 - 0.28).

Therefore, 5% = 6% (1 - tax rate)

Let (1 - tax rate) be x.

That is 0.05 = 0.06x

x = 0.05/0.06 = 0.8333

Therefore, (1 - tax rate) = 0.8333

Tax rate = 1 - 0.8333

Tax rate = 0.1667

Check: if 5% = 6% (1 - tax rate)

0.05 = 0.06 (1 - 0.1667)

0.05 = 0.049998

0.05 = 0.05

The above calculation shows that if Fund B is taxed at 16.67% instead of 28%, it would have identical yields with Fund A.