Series 7 practice questionmediumDebt Securities — Municipal Bonds — Taxable Equivalent Yield
An investor in the 32% federal tax bracket is considering a municipal bond yielding 4%. What is the taxable equivalent yield?
- A4.00%
- B5.26%
- C5.88%✓ Correct answer
- D12.50%
Explanation
Why C — 5.88%
Taxable equivalent yield (TEY) is calculated as: Municipal Yield / (1 - Tax Rate) = 4% / (1 - 0.32) = 4% / 0.68 = 5.88%. This means the investor would need a taxable bond yielding 5.88% to have the same after-tax return as the 4% municipal bond. TEY helps investors compare tax-exempt municipal bonds with taxable alternatives.
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