Suppose you\'re evaluating three alternative MMMF investments. The first fund bu

Question

Suppose you're evaluating three alternative MMMF investments. The first fund buys a diversified portfolio of municipal securities from across the country and yields 3.2 percent. The second fund buys only taxable, short-term commercial paper and yields 4.9 percent. The third fund specializes in the municipal debt from the state of New Jersey and yields 3.0 percent. If you are a New Jersey resident, your federal tax bracket is 35 percent, and your state tax bracket is 8 percent, which of these three MMMFs offers you the highest after-tax yield? Which MMMF offers you the highest yield if you arc a resident of Texas, which has no state incomc tax?

Explanation / Answer

New Jersey Resident:

Option 1 after tax yield= 3.2%

Option 2 after tax yield= 4.9%*(1-35%)*(1-8%)=2.93%

Option 3 after tax Yield=3.0%

Assessing above options Option 1 is the highest yielding option. Municipal securities do not attract any federal or state taxes which is major advantage for them.

If resident of Texas:

Option 1 after tax yield= 3.2%

Option 2 after tax yield= 4.9%*(1-35%)=3.19%

Option 3 after tax Yield=3.0%

Here option1 and option 2 are very close choices. But option 1 might provide more secuirty as it is backed by munis.

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