Yields of a Bond A 3.25 percent coupon municipal bond has 12 years left to maturity and has a price quote of 98.75. The bond can be called in 5 years. The call premium is one year of coupon payments. What is the bond's taxable equivalent yield for an investor in the 35 percent marginal tax bracket? (Assume interest payments are paid semi-annually and a par value of $5,000.)

Question

Quizplus · Accepted Answer

To calculate the taxable equivalent yield, we need to first find the bond's yield to maturity (YTM). Using a financial calculator, we can input the following information:

N = 24 (since there are 12 years left to maturity and interest payments are made semi-annually)
I/Y = 1.676% (since the bond is currently priced at 98.75)
PV = -4,937.50 (since this is the present value of the future cash flows)
PMT = 81.25 (since the bond pays a semi-annual coupon of $81.25, or 3.25% of the $5,000 par value)
FV = 5,000 (since this is the par value of the bond)

Solving for I/Y gives us a YTM of 3.36%.

Next, we need to calculate the tax-equivalent yield for an investor in the 35% marginal tax bracket. We can do this by dividing the YTM by (1 - 0.35), which represents the portion of the yield that the investor gets to keep after paying taxes. Therefore, the taxable equivalent yield is:

3.36% / (1 - 0.35) = 5.20%

Therefore, the best choice is C, with a taxable equivalent yield of 5.20%.

Yields of a Bond a 3