CFA Level I · CFA Level I Exam · Fixed-Income Instrument Features
An investor in a jurisdiction that taxes coupon income at 30% considers a tax-exempt municipal bond yielding 4.2% and a taxable bond of equal risk. The taxable bond yield that would leave the investor indifferent after tax is closest to:
The indifference yield is about 6.0%. Divide the tax-exempt yield of 4.2% by one minus the 30% tax rate, giving 4.2% / 0.70 = 6.0%. A taxable bond yielding 6.0% leaves 4.2% after tax, equal to the exempt bond.
- A5.4%
- B6.0%Correct
- C7.0%
Explanation
Taxable-equivalent yield = tax-exempt yield / (1 - tax rate) = 4.2% / 0.70 = 6.0%. Check: 6.0% x 0.70 = 4.2%. The 7.0% distractor wrongly divides by 0.60; 5.4% adds 30% of 4.2% less something erroneously (4.2% x 1.3 = 5.46%), a wrong gross-up.
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