Question

Suppose you’re evaluating three alternative MMMF investments. The first fund buys a diversified portfolio of municipal securities from across the country and yields 3.7 percent. The second fund buys only taxable, short-term commercial paper and yields 6.2 percent. The third fund specializes in the municipal debt from the state of New Jersey and yields 3.9 percent. Your federal income tax rate is 35 percent and you are a resident of Texas, which has no state income tax.

a. Calculate the after-tax yield for each of the alternatives. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

After-tax Yield

Municipal Fund%:

Taxable Fund%:

New Jersey Municipal Fund%:

___________________________________________________________

Which of these three MMMFs offers you the highest after-tax yield?

• Taxable Fund

• Municipal Fund

• New Jersey Fund

Answer 1

(a)-After-tax Yield for each alternative

Municipal Fund

Municipal Fund After-tax yield = 3.70% (Since, it there is no state income tax)

Taxable Fund

Taxable Fund After-tax yield = Yield x (1 – Federal Tax Rate)

= 6.20% x (1 – 0.35)

= 6.20% x 0.65

= 4.03%

New Jersey Municipal Fund

New Jersey Municipal Fund After-tax yield = 3.90% (Since, it there is no state income tax)

(b)- Which of these three MMMFs offers you the highest after-tax yield

“TAXABLE FUND” offers the highest after-tax yield (4.03%).