A municipal bond carries a coupon of 6 3/4% and is trading at par. What is the equivalent taxable yeild to a taxpayer in a combined federal plus state 34% tax bracket? I calculated 10.23%, is that correct?
6.75%/(1-0.34) = 10.23% correct!
To calculate the equivalent taxable yield to a taxpayer in a combined federal and state tax bracket, you need to take into account the tax-exempt nature of municipal bonds and the taxpayer's tax bracket. Here's how you can calculate it step by step:
1. Start by determining the after-tax yield of the tax-exempt municipal bond. To do this, you subtract the tax benefit from the coupon rate.
Tax-exempt yield = Coupon rate - (Coupon rate * Tax rate)
In this case, the coupon rate is 6 3/4% or 6.75%, and the tax rate is 34% (combined federal and state tax bracket).
Tax-exempt yield = 6.75% - (6.75% * 0.34)
2. Calculate the taxable equivalent yield by dividing the tax-exempt yield by (1 - Tax rate).
Taxable equivalent yield = Tax-exempt yield / (1 - Tax rate)
Taxable equivalent yield = (6.75% - (6.75% * 0.34)) / (1 - 0.34)
3. Simplify the calculation:
Taxable equivalent yield = (6.75% - 2.295%) / 0.66
Taxable equivalent yield = 4.455% / 0.66
Taxable equivalent yield ≈ 6.75%
The taxable equivalent yield is approximately equal to the coupon rate of the municipal bond, which is 6.75%. Therefore, the calculated yield is not 10.23%, but rather 6.75%. If you obtained a different result, please recheck your calculations.