An investor in the 32% federal tax bracket is considering a municipal bond yielding 4%. What is the taxable equivalent yield?

Why D — 5.88%

Taxable equivalent yield = tax-free yield / (1 - tax rate) = 4% / (1 - 0.32) = 4% / 0.68 = 5.88%. This means a taxable bond would need to yield 5.88% to provide the same after-tax return as a 4% municipal bond for someone in the 32% bracket. Higher tax brackets benefit more from tax-exempt municipal bond income.