Question

s Calculation (20%) Table 2.2 Tax-Exempt Yield Equivalent taxable yields corresponding to various tax-exempt yields 2% 3% 4% 5% 1% Marginal Tax Rate 125% 2.50% 3.75% 5.00% 6.25% 20% 30 1,43 2.86 4.29 5.71 7.14 40 1.67 3.33 5.00 6.67 8.33 50 2.00 4.00 6.00 8.00 10.00 Suppose your tax bracket is 40%, would you rather hold a 7% taxable bond or a % tax-free bond? What is the equivalent taxable yield of the 5%tax-free yield?

Answer 1

Ans - (i) As per the question, it is given that that tax-exempt yield for 5% if the tax bracket falls in 40% is 8.33%.

From the table analysis it clear that it is wise to hold a 5% tax-free bond rather than 7% taxable bond because the equivalent taxable yield for 5% is 8.33% which is more than 7% taxable yield of the bond.

(ii) The equivalent taxable yield for 5% tax-free yield is 8.33%.