NASAA Series 65, Uniform Investment Adviser Law ExaminationClient Investment Recommendations and StrategiesMedium
A client is considering investing in a municipal bond fund. They are in the 32% federal income tax bracket and a 5% state income tax bracket. The municipal bond fund offers a tax-exempt yield of 4.5%. What is the taxable equivalent yield of this municipal bond fund for this client?
- A6.62%
- B7.14%
- C4.50%
- D5.00%
Show answer & explanationAnswer & explanation
Correct answer: B. 7.14%
To calculate the taxable equivalent yield, we use the formula: Tax-Exempt Yield / (1 - Marginal Tax Rate). The marginal tax rate is the combined federal and state rate: 32% + 5% = 37% or 0.37. So, 4.5% / (1 - 0.37) = 4.5% / 0.63 = 0.071428, or approximately 7.14%.
Why the other options are wrong
- A. Incorrect calculation, likely using only federal tax rate or other error.
- C. This is the tax-exempt yield, not the taxable equivalent yield.
- D. Incorrect calculation.
Taxable Equivalent Yield
The yield that a taxable bond must offer to provide the same after-tax return as a tax-exempt municipal bond.
- Formula: Tax-Exempt Yield / (1 - Marginal Tax Rate).
- Used to compare municipal bonds with corporate bonds.
- Considers both federal and state income tax rates.
Memory trick: Tax-exempt yield divided by one minus your total tax rate.