Question

A municipal bond carries a coupon rate of 6¾% and is trading at par. What would be the equivalent taxable yield of this bond to a taxpayer in a 35% tax bracket?

Short answer

The correct answer is 10.38% or 0.1038.

Step-by-step solution

Definition

The municipal bonds are tax exempt bonds issued by state and local governments.

Solution

Formula for computation of equivalent taxable yield is r= r_muni where r is Tax equivalent yield, the tax rate is t and r_muniis Yield on municipal bond

r = r_muni/1-t

r = 6.75%/1-35%

r = 6.75% / 0.65%

r = 10.38%

r = 0.1038

So, the equivalent taxable yield to a taxpayer in a combined federal plus state 35% tax bracket is 10.38% or 0.1038.