1) If an investor can buy-and-hold a tax advantage (i.e., tax exempt) security t
ID: 2750170 • Letter: 1
Question
1) If an investor can buy-and-hold a tax advantage (i.e., tax exempt) security that yields 6.25% and faces a marginal tax rate of tax rate of 20%, what rate of return must be earned on a taxable investment to match the tax-exempt yield?
2) If a taxable yield for a given investment is 11.15%, and the investor faces a marginal tax rate of 25%, what is the equivalent yield on a tax-free investment?
3) If an investors buys 200 shares of FYI and has an initial margin requirement of 60%, and the total value of the purchase is $8000, what is the implied per share purchase price of FYI and the dollar amount of the margin loan.
4) If an investor account is under-margined, then the following action or actions need to be taken:
I. Add cash or securities
II. Pay off part of loan
III. Sell shares and apply proceeds to pay off part of loan
Explanation / Answer
1)Taxable equivalent yield= Tax exempt yield/(1-marginal tax rate)
=6.25%/(1-20%)=7.813%
A taxable bond that has yield of 7.813% is equivalent to tax exempt bond of 6.25% with 20% marginal tax rate slab.
2)Taxable equivalent yield= Tax exempt yield/(1-marginal tax rate)
Tax exempt yield=11.15%*(1-25%)=8.363%
4)all the three actions can be done.
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