Question

Suppose you’re evaluating three alternative MMMF investments. The first fund buys a diversified portfolio of municipal securities from across the country and yields 4.4 percent. The second fund buys only taxable, short-term commercial paper and yields 5.9 percent. The third fund specializes in the municipal debt from the state of New Jersey and yields 4.1 percent. You are a New Jersey resident, your federal tax bracket is 35 percent, and your state tax bracket is 8 percent. (Assume your state taxes do not affect your federal taxable income.)

1. Calculate the after-tax yield for each of the alternatives. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

	After-tax Yield Municipal Fund % Taxable Fund % New Jersey Municipal Fund %

2. Which of these three MMMFs offers you the highest after-tax yield?

• Taxable Fund

• New Jersey Fund

• Municipal Fund

Answer 1

1.

	after tax yield
municipal fund	4.05%
Taxable fund	3.36%
new jersey municipal fund	4.10%

2.New jersey fund

New jersey fund offers the highest after tax return.

working:

municipal fund is affected only by state taxes = 4.4% *(1-0.08)=>4.05%.

taxable fund is affected by both state and federal taxes = 5.9%*(1-0.35-0.08)=>3.36%.

new jersey fund is not affected by taxes for New Jersey resident.