Products & Their RisksQuestion 121 of 398
The taxable-equivalent yield of a municipal bond is used to:
a.Compare a tax-exempt muni yield to the pre-tax yield a taxable bond must offer to be equally attractive
b.Measure the bond's yield after subtracting the federal income tax owed on the coupon
c.Calculate the state tax a nonresident owes on municipal interest
d.Determine the bond's yield to maturity net of the dealer's markup
Explanation
Taxable-equivalent yield converts a tax-free municipal yield into the higher pre-tax yield a taxable bond would need in order to leave an investor with the same after-tax return. It lets an investor compare munis and taxable bonds on an apples-to-apples basis, and the higher the investor's tax bracket, the larger the advantage of the muni.
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