Asked by Chris Mangunza on Jul 12, 2024
Verified
An investor in a 28% tax bracket is trying to decide whether to invest in a municipal bond or a corporate bond. She looks up municipal bond yields (rm) but wishes to calculate the taxable equivalent yield r. The formula she should use is given by ________.
A) r = rm × (1 - 28%)
B) r = rm / (1 - 72%)
C) r = rm × (1 - 72%)
D) r = rm / (1 - 28%)
Municipal Bond
A bond issued by local or state governments to finance public projects, often offering tax-exempt interest payments.
Taxable Equivalent Yield
Taxable equivalent yield calculates the yield a taxable bond needs to match the after-tax yield of a tax-exempt bond, considering the investor's tax rate.
Tax Bracket
A range of incomes taxed at a particular rate, with progressive tax systems applying higher rates to higher income levels.
- Comprehend the role of taxation in investment decision-making and compute taxable equivalent yields.
Verified Answer
UW
Unique WalkerJul 14, 2024
Final Answer :
D
Explanation :
To calculate the taxable equivalent yield, we need to find the yield on a corporate bond that is equivalent to a municipal bond yield after adjusting for taxes. The formula to calculate taxable equivalent yield is r = rm / (1 - tax rate). In this case, the tax rate is 28%, so the correct formula is r = rm / (1 - 0.28) or r = rm / 0.72. The only option that matches this formula is D.
Learning Objectives
- Comprehend the role of taxation in investment decision-making and compute taxable equivalent yields.