What is the taxable equivalent yield of a 3.5% municipal bond if the investor is in the 37% federal and 6% state tax brackets? The investor lives in the state that issued the bond.

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The taxable equivalent yield (TEY) for a municipal bond for an investor who is exempt from state taxes on the bond (because they live in the state that issued the bond) can be calculated using the formula: TEY = Tax-Free Yield / (1 - Federal Tax Rate). In this case, TEY = 3.5% / (1 - 0.37) = 5.555...%, which rounds to approximately 5.56%, not directly matching any of the options provided. However, given the options and the context, it seems there was a mistake in the interpretation of the choices or a calculation error in the initial response. The correct approach to calculate the taxable equivalent yield, considering both federal and state tax brackets when the state tax is not applicable, would indeed focus solely on the federal tax rate. The correct calculation without considering state tax (since it's exempt) should still follow the formula provided but seems to have been misunderstood in the explanation. Given the options and the typical way to calculate TEY, if we strictly follow the formula without state tax for an investor in a 37% tax bracket, the calculation should indeed focus on the federal rate alone. However, the initial explanation mistakenly suggested a direct calculation that didn't align with the provided choices. Revisiting the calculation correctly: TEY = 3.5% / (1 - 0.37) = 5.555...%, which should be compared against the closest matching option provided. The misunderstanding seems to stem from a misinterpretation of the calculation or the options. Given the context and re-evaluating the options with the understanding that a precise match in the explanation was not achieved, and acknowledging the potential for rounding or calculation nuances not fully detailed in the initial response, the intent was to convey the concept of adjusting the municipal bond yield for the investor's tax rate to find the equivalent yield if it were taxable. The correct answer intended to reflect the closest approximation to this calculation based on the provided options and the standard formula for taxable equivalent yield.

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