🏦LTB
← Series 7: Investment Information & Recommendations
Series 7 practice questionmediumTax Implications — Tax-Equivalent Yield

An investor in the 24% tax bracket earns 3.00% on a municipal bond. A corporate bond yields 4.25%. Which provides a better after-tax return?

  1. AThe municipal bond with a tax-equivalent yield of 3.95%
  2. BThe corporate bond with an after-tax yield of 3.23%✓ Correct answer
  3. CThe corporate bond with an after-tax yield of 4.25%
  4. DThey are equivalent
Explanation

Why B — The corporate bond with an after-tax yield of 3.23%

Municipal TEY = 3.00% / (1 - 0.24) = 3.00% / 0.76 = 3.95%. Corporate after-tax yield = 4.25% x (1 - 0.24) = 4.25% x 0.76 = 3.23%. The corporate bond yields 4.25% before tax but only 3.23% after tax. The municipal bond's tax-equivalent yield of 3.95% is less than the corporate bond's 4.25% pre-tax yield. However, comparing after-tax: muni gives 3.00% tax-free vs corporate 3.23% after tax. The corporate bond provides a better after-tax return in this case.

Turn it into reps

Reading one answer is not the same as being ready

Lucky the Banker is a free practice app with 755+ Series 7 questions, weak-area tracking, and timed mock exams. No credit card, no paywall.

Practice Series 7 freeSeries 7 exam guide
Related Investment Information & Recommendations questions