2. A bank is considering an investment in a municipal security that offer a yield of 6 percent. What is the security’s tax equivalent yield if the bank’s tax rate is 35 percent
1. A bank is considering two securities: a 30 year Treasury bond yielding 7 percent and a 30-year municipal bond yielding 5 percent. If the bank’s tax rate is 30 percent, which bond offers the higher tax equivalent yield?
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To calculate the tax equivalent yield, we need to determine the taxable yield that would be equivalent to the tax-free yield of 6 percent.
The tax equivalent yield formula is:
Tax Equivalent Yield = Tax-free Yield / (1 - Tax Rate)
In this case, the tax-free yield is 6 percent and the tax rate is 35 percent. Let's plug in the values and calculate the tax equivalent yield:
Tax Equivalent Yield = 6% / (1 - 0.35)
= 6% / 0.65
= 9.23%
Therefore, the tax equivalent yield for the municipal security, considering a 35 percent tax rate, is 9.23 percent.