Security A is a fully taxable security that earns 5% annually.Security B is a tax-exempt municipal security.If a short-term investment manager uses a tax rate of 33%,what yield must security B earn such that the investment manager would be indifferent between securities A and B?

Question

Quizplus · Accepted Answer

To compare the two securities, we need to calculate the after-tax yield for Security A first:
After-tax yield for Security A = 5% x (1 - 0.33) = 3.35%
Therefore, for the investment manager to be indifferent between the two securities, Security B must also earn a 3.35% after-tax yield. Since Security B is tax-exempt, its pre-tax yield is the after-tax yield we need to calculate:
Pre-tax yield for Security B = 3.35% / (1 - 0) = 3.35%
Therefore, Security B must earn a pre-tax yield of 3.35%. The correct answer is B.

Security a Is a Fully Taxable Security That Earns 5