Question

A tax-exempt municipal bond with a coupon rate of 6.00% has a market price of 99.18% of par. The bond matures in 13.00 years and pays semi-annually. Assume an investor has a 35.00% marginal tax rate. The investor would prefer otherwise identical taxable bond if it's yield to maturity was more than _____% ( round to 2 decimal places)

Answer 1

Calculating Yield on Tax Exempt Bond

using financial calculator,

n = 13 x 2 = 26

PV = -99.18

PMT = 100 x 6%/2 = 3

FV =100

Compute I/Y = 3.046% (rounded off)

YTM = 3.046% x 2 =6.092%

Yield to Maturity on the Taxable Bond (1-tax rate) = Yield to Maturity on Tax exempt Bond

Yield to Maturity on the Taxable Bond (1-0.35) =6.092%

Yield to Maturity on the Taxable Bond = 6.06% / (1-0.35)

Yield to Maturity on the Taxable Bond = 9.372% (rounded off)

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