A client in the 26 percent marginal tax bracket is comparing a municipal bond that offers a 6.4 percent yield to maturity and a similar-risk corporate bond that offers a 9.10 percent yield.
Determine the equivalent taxable yield. (Round your answer to 2 decimal places.)
Equivalent taxable yield %
Which bond will give the client more profit after taxes?
_____ Corporate bond
_____ Municipal bond
To determine the equivalent taxable yield, we need to compare the after-tax yields of both bonds.
For the municipal bond, the yield of 6.4% is tax-free. Therefore, the after-tax yield is also 6.4%.
For the corporate bond, we need to calculate the after-tax yield based on the client's marginal tax bracket of 26%.
After-tax yield for corporate bond = Yield * (1 - Tax Rate)
After-tax yield = 9.10% * (1 - 0.26) = 6.738%
Now we compare the after-tax yields of both bonds.
The equivalent taxable yield is the yield that the municipal bond would have to offer to match the after-tax yield of the corporate bond.
Therefore, the equivalent taxable yield is 6.738%.
According to the comparison, the corporate bond has a higher after-tax yield of 6.738% compared to the municipal bond's after-tax yield of 6.4%.
Hence, the corporate bond will give the client more profit after taxes.
To determine the equivalent taxable yield, we need to calculate the yield on the municipal bond after accounting for its tax-free status.
1. First, we calculate the after-tax yield on the municipal bond. Since municipal bond interest is tax-free, the after-tax yield on the municipal bond is the same as the yield to maturity, which is 6.4 percent.
2. Next, we determine the taxable equivalent yield. To do this, we need to find the yield on the corporate bond that would provide the same after-tax return as the municipal bond.
Let's calculate the taxable equivalent yield:
Taxable equivalent yield = Municipal bond yield / (1 - Marginal tax rate)
Taxable equivalent yield = 6.4% / (1 - 0.26)
Taxable equivalent yield = 6.4% / 0.74
Taxable equivalent yield ≈ 8.65%
Therefore, the equivalent taxable yield is approximately 8.65%.
Now, the client can compare the equivalent taxable yield of 8.65% on the corporate bond to the yield of 9.10% on the municipal bond.
Since the yield on the corporate bond is higher (9.10%), the client will have more profit after taxes from the corporate bond. It is the better option for the client.
So, the answer is:
Corporate bond - X
Municipal bond - ✓