You may attempt this question 3 more times for credit. Ye Yuan is in retirement
ID: 2619796 • Letter: Y
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 Bank CD offering a quoted yield of 7.08% A Massachusetts Municipal bond offering a quoted yield of 4.91% Ye pays federal tax at the rate of 24% and tax to the state of Massachusetts (his state residency) of 8% Ye estimates that the Massachusetts municipal bond has a 1% chance of default and that the bank CD has a 2% 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 Bank CD offer after adjusting for tax and credit risk? If the believe that the CD 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 0.63Explanation / Answer
We will have to calculate the after-tax yield on Bank CD and Municipal Bond to arrive at a decision.
The yield on Bank CD is taxable both at the federal and state level. Therefore the after-tax yield on Bank CD will be calculated as below:
After-Tax Yield (Bank CD) = Quoted Yield *(1-(Federal Tax Rate + State Tax Rate)) = 7.08%*(1-(24% + 8%)) = 4.81%
If the investor purchases municipal bonds issued by an agency of his own state, the interest income received from such bonds is exempt at the state level. Further, yield on municipal bonds is exempt at the federal level. Therefore, the after-tax yield on municipal bonds will continue to be 4.91%.
As the after-tax yield on municipal bonds is higher than the after-tax yield on Bank CD and default rate on Bank CD is higher than municipal bonds, Ye Yuan should invest in municipal bonds.
The Bank CD is providing .10% (4.91% - 4.81%) less in the yield when compared with municipal bonds.
Difference in Yield = -0.10%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.