Karen Callaway is an investor in the 35% tax bracket. She is evaluating a tax-exempt municipal security with a tax-exempt yield of 4.5%. What is the taxable equivalent yield (TEY) of the municipal security?
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A. B. C.C
To calculate the taxable equivalent yield (TEY) of a tax-exempt municipal security, you need to determine the yield that a taxable security would have to offer in order to provide the same after-tax return as the tax-exempt security.
In this case, Karen Callaway is in the 35% tax bracket. The tax-exempt yield of the municipal security is 4.5%.
To calculate the TEY, you can use the following formula:
TEY = Tax-Exempt Yield / (1 - Tax Rate)
where the tax rate is expressed as a decimal (35% = 0.35).
Let's plug in the values:
TEY = 4.5% / (1 - 0.35)
Simplifying the equation:
TEY = 4.5% / 0.65
TEY ≈ 6.9231%
Therefore, the taxable equivalent yield (TEY) of the municipal security is approximately 6.9231%.
Among the answer choices provided:
A. 2.9% B. 6.9% C. 12.9%
The correct answer is B. 6.9%, which is the closest approximation to the calculated taxable equivalent yield (TEY).