Currently, a three-year Treasury note pays 4.75%. Assuming that your tax rate is 20%, what is the minimum interest rate that you would you need to earn on a tax-free municipal bond in order to buy it instead?
A)0.95%
B)3.8%
C)5.7%
D)15.25%

Question

Quizplus · Accepted Answer

To find the minimum interest rate needed on the tax-free municipal bond, we need to calculate the taxable equivalent yield (TEY) of the municipal bond. 
TEY = tax-free yield / (1 - tax rate)
TEY = x / (1 - 0.20) 
TEY = x / 0.80

We want to find x, so we can solve for x:
x / 0.80 = 4.75
x = 4.75 * 0.80
x = 3.8

Therefore, the minimum interest rate needed on the tax-free municipal bond is 3.8%, which is option B.

Currently, a Three-Year Treasury Note Pays 4