You may attempt this question 3 more times for credit. Ye Yuan is in retirement

Question

You may attempt this question 3 more times for credit. Ye Yuan is in retirement and is considering investing in one of the following two money market securities: A US Treasury Bill offering 6.74% A Massachusetts Municipal bond offering 4.78% Ye pays Federal tax at the rate of 32% and tax to the state of Massachusetts (his state residency) of 8%. Ye estimates that the US Treasury Bill has zero risk of default, and that the Massachusetts municipal bond has a 1% chance of default. Because the quoted yield is before tax and credit risk adjustments, Ye is interested in determining which of these two bonds is best. How much more (or less) in yield does the Treasury Bill offer after adjusting for tax and credit risk? If the believe that the Treasury Bill is best, then enter the differential as a positive number. If you believe the municipal is best, then enter the differential as a negative number. Difference in yield Place your answer as a percent without the percentage sign. For example, if your answer is zero point six three percent, then enter your answer as 0.63

Explanation / Answer

Solution:

Treasury bill yields are taxed at the federal level, the tax rate is 32% and before tax yield is 6.74%

After-tax yield = before tax yield * ( 1 - Tax rate ) = 6.74% * (1 -0.32) = 4.583%

The municipal bond is offering 4.78%

Municipal bond yield will be taxed at the state level and state tax is 8% and default chance of this bond is 1%

Risk-adjusted return = 4.78% * ( 1- 0.01) = 4.7322%

After tax return = 4.7322 * ( 1 - tax rate) = 4.7322% * ( 1-0.08) = 4.3536%

Difference = 4.583% - 4.3536% ? = 0.2294 = 0.23

Ans: 0.23

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.