Question

"A 7%, 15-year corporate bond is priced to yield 7.50%. For an investor in the 28% tax bracket, the equivalent tax free yield is:"

Answer 1

The equivalent tax-free yield is:

10.42%

Step-by-step explanation:

Tax-free yield = 7.5%/(1 - 28%)

= 10.42%

This equivalent tax-free yield is the yield of the 7%, 15-year corporate bond that will make it comparable to a municipal bond that is tax-free. To calculate the tax-free yield, we divide the yield rate by the inverse of the tax bracket. In this case, this yields 10.42%. This implies that for this corporate bond to be valued equally with a municipal tax-free bond, the yield must be at least 10.42%.