FINRA Series 7Investment Information and Suitable RecommendationsEasy
A client is in the 30% federal income tax bracket and 5% state income tax bracket. They are considering purchasing a municipal bond with a 4% coupon rate. What is the taxable equivalent yield?
- A7.27%
- B5.33%
- C6.15%
- D4.00%
Show answer & explanationAnswer & explanation
Correct answer: C. 6.15%
The taxable equivalent yield accounts for both federal and state taxes. The combined tax rate is 30% + 5% = 35%. The taxable equivalent yield is calculated as the municipal yield divided by (1 - combined tax rate).
Why the other options are wrong
- A. This calculation would result from an incorrect combined tax rate or formula.
- B. This calculation only considers the federal tax rate (4% / (1 - 0.30) = 5.71%).
- D. This is the municipal bond's coupon rate, not the taxable equivalent yield.
Taxable Equivalent Yield (TEY)
The yield a taxable bond must offer to match the after-tax return of a tax-exempt municipal bond, considering both federal and state income taxes.
- Compares tax-exempt municipal bond returns to taxable investments.
- Accounts for both federal and state income tax rates.
- Formula: Municipal Yield / (1 - Combined Tax Rate).
Memory trick: Tax-Free Muni, Taxable Equivalent - What's the 'real' gain?