After tax yield on muni bond on QBank question, provides, equivalent, carries, copyright

sweetgirl

I've changed the terms to avoid any copyright hoopla:

A municipal bond carries a coupon of 7% and is traded at par. To a taxpayer in the 34% tax bracket, this bond provides an equivalent taxable yield of:

A) 10.61%.

B) 7.00%.

C) 9.09%.

I chose B, as I thought muni bonds were tax exempt and figured this was a trick question (no tax levied, after tax yield equals current yield). The answer given by Schweser is A using the usual tax equivalent formula:

Coupon / (1 - T)
7 / 0.66 = 10.61

Any explanation as to why a muni trading at par has a tax equivalent yield not equal to current yield in this instance?

cchang

a muni is not taxed

so if you have a 10.61 corporate bond

it will be taxed 0.34

and you would be left with 7, thus the taxable equivilant is a 10.61 corporate

dont take this the wrrong way buddy, but IF you face a lot of such issues you better put a lot of work. it is too close to the exam for you to be wondering about this...it is a very basic question

note i dont meen to freak you out, just an advice cause i dont want you to fail



Edited 1 time(s). Last edit at Tuesday, May 17, 2011 at 02:24PM by gulfcfa.

Kiakaha

Thanks, Chief.

I glossed over the word "equivalent". I don't know how I just did 20 similar Q-Bank questions in a row then somehow lost my mind on this one.

Note, a critique of my perceived study habits was not part of my original query, but thank you for your concern.

Maddin

Starting to get ugly around here.