CFA Level I · CFA Level I Exam · Fixed-Income Cash Flows and Types
A taxable investor with a marginal tax rate of 30% on interest considers a tax-exempt municipal bond yielding 3.50%. A taxable bond of similar credit quality and maturity is available. The taxable yield that would give the same after-tax return as the municipal bond is closest to:
The taxable-equivalent yield is closest to 5.00%. Divide the tax-exempt yield of 3.50% by one minus the 30% tax rate, giving 3.50% / 0.70 = 5.00%. A taxable bond yielding 5.00% leaves 3.50% after tax, matching the municipal bond.
- A2.45%
- B3.50%
- C5.00%Correct
Explanation
Taxable-equivalent yield = 3.50% / (1 − 0.30) = 3.50% / 0.70 = 5.00%. Check: 5.00% × 0.70 = 3.50%. The 2.45% option wrongly multiplies by 0.70.
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