An investor in a 28% tax bracket needs to receive what taxable return on a corporate bond to equal a 7.2% tax-free yield?

An investor in a 28% tax bracket needs to receive what taxable return on a corporate bond to equal a 7.2% tax-free yield?

• A. 7.2%
• B. 10%
• C. 25.7%
• D. 28%

Answer: (B)

To determine the taxable return needed to equal a 7.2% tax-free yield for an investor in a 28% tax bracket, it's essential to understand the relationship between taxable and tax-exempt yields. The formula to convert a tax-free yield to a taxable equivalent yield is: Taxable Yield = Tax-Free Yield / (1 - Tax Rate). In this case, the tax-free yield is 7.2%, and the tax rate is 28%, or 0.28 in decimal form. Plugging these values into the formula gives: Taxable Yield = 7.2% / (1 - 0.28) = 7.2% / 0.72 = 10%. This means that the investor would need to receive a 10% return on a taxable corporate bond to achieve the same after-tax return as a 7.2% yield on a tax-free bond. When considering their tax rate, this effectively translates the tax-free yield into its taxable equivalent. Therefore, an investor in a 28% tax bracket needs a 10% taxable return to equal the 7.2% tax-free yield, confirming that this is indeed the correct answer.

To determine the taxable return needed to equal a 7.2% tax-free yield for an investor in a 28% tax bracket, it's essential to understand the relationship between taxable and tax-exempt yields.

The formula to convert a tax-free yield to a taxable equivalent yield is:

Taxable Yield = Tax-Free Yield / (1 - Tax Rate).

In this case, the tax-free yield is 7.2%, and the tax rate is 28%, or 0.28 in decimal form. Plugging these values into the formula gives:

Taxable Yield = 7.2% / (1 - 0.28)

= 7.2% / 0.72

= 10%.

This means that the investor would need to receive a 10% return on a taxable corporate bond to achieve the same after-tax return as a 7.2% yield on a tax-free bond. When considering their tax rate, this effectively translates the tax-free yield into its taxable equivalent.

Therefore, an investor in a 28% tax bracket needs a 10% taxable return to equal the 7.2% tax-free yield, confirming that this is indeed the correct answer.