NASAA Series 66 — All Questions

Common stock represents:

• a.A guaranteed dividend obligation
• b.A short-term money market instrument
• c.A creditor claim with fixed interest
• d.An ownership equity interest with voting rights and residual claims✓

Common stock is an equity ownership interest granting voting rights and a residual claim on assets and earnings after creditors and preferred holders. Dividends are not guaranteed. Shareholders participate in growth but bear the greatest risk in liquidation.

Preferred stock differs from common stock primarily because it:

• a.Has unlimited upside like a growth stock
• b.Always carries greater voting power
• c.Is a debt instrument with a maturity date
• d.Generally pays a fixed dividend and has priority over common in dividends and liquidation✓

Preferred stock typically pays a fixed dividend and ranks ahead of common stock for dividends and in liquidation, though usually without voting rights. It behaves partly like a fixed-income security due to its fixed payment. Its price is sensitive to interest rates.

A bond's price and prevailing interest rates generally have what relationship?

• a.They are unrelated
• b.They move in opposite directions✓
• c.They are always equal
• d.They move in the same direction

Bond prices and interest rates move inversely: when rates rise, existing bond prices fall, and when rates fall, prices rise. This reflects the fixed coupon becoming relatively less or more attractive. Longer maturities amplify this sensitivity.

A zero-coupon bond:

• a.Is issued at a discount and pays no periodic interest, maturing at face value✓
• b.Is always tax-free
• c.Pays semiannual interest at a high rate
• d.Has no interest-rate risk

A zero-coupon bond is sold at a discount to face value and pays all its return at maturity, with no periodic coupons. Its long effective duration makes it highly sensitive to interest-rate changes. Holders may owe tax annually on imputed interest despite receiving no cash.

An open-end investment company (mutual fund):

• a.Continuously issues and redeems shares at net asset value✓
• b.Pays fixed interest and repays principal at maturity
• c.Trades on an exchange at a premium or discount to NAV like a closed-end fund
• d.Has a fixed number of shares that never changes

An open-end investment company continuously offers new shares and stands ready to redeem outstanding shares at net asset value. The fixed share count and the exchange trading at a premium or discount describe a closed-end fund instead. A fund holds a portfolio of securities and is not a debt instrument that pays fixed interest and returns principal at maturity.Investment Company Act of 1940 Sec. 5(a)(1), 15 USC 80a-5(a)(1)

A closed-end fund's shares:

• a.Are continuously issued and redeemed by the fund itself
• b.Are always redeemed at net asset value
• c.Are priced once a day at the next-computed NAV
• d.Trade on an exchange and may sell at a premium or discount to NAV✓

A closed-end company is any management company that is not open-end, meaning it does not offer or have outstanding redeemable securities. It sells a fixed number of shares in an offering, and those shares then trade on an exchange or in the market, where supply and demand can push the price above or below net asset value. Continuous issuance and redemption by the fund itself is the open-end structure, not this one. Redemption at net asset value is also an open-end feature, because a closed-end fund does not buy its shares back on demand. Once-a-day pricing at the next-computed NAV applies to open-end fund purchases and redemptions, whereas closed-end shares are priced throughout the day like stocks.Investment Company Act of 1940 Section 5(a) (15 U.S.C. 80a-5(a))

A call option gives the holder the right to:

• a.Obligate the writer to buy shares
• b.Receive a fixed dividend
• c.Sell the underlying at the strike price
• d.Buy the underlying at the strike price before expiration✓

A call option grants the holder the right, but not the obligation, to buy the underlying security at the strike price before expiration. The buyer profits if the underlying rises above the strike plus premium. The writer is obligated to sell if assigned.

A put option is generally used by an investor who:

• a.Seeks unlimited upside from appreciation
• b.Wants to profit from or hedge against a decline in the underlying price✓
• c.Wants to guarantee dividend income
• d.Expects the underlying price to rise sharply

A put option gives the holder the right to sell the underlying at the strike price and gains value as the underlying falls. Investors buy puts to speculate on declines or to hedge existing long positions. It is a bearish or protective strategy.

A variable annuity's separate account value during the accumulation phase:

• a.Is guaranteed by the insurer at a fixed rate
• b.Cannot lose value
• c.Fluctuates with the performance of the underlying investment subaccounts✓
• d.Is insured by the FDIC

In a variable annuity, contributions are allocated to subaccounts whose value rises and falls with market performance, so the investor bears the investment risk. Unlike a fixed annuity, there is no guaranteed accumulation rate. It is a security because of this investment risk.

A fixed annuity is characterized by:

• a.FDIC insurance
• b.Investment risk borne entirely by the contract holder
• c.A guaranteed minimum interest rate and fixed payments backed by the insurer✓
• d.Values tied to equity subaccounts

A fixed annuity provides a guaranteed minimum interest rate and fixed payments, with the insurer bearing the investment risk from its general account. Because there is no investment risk to the holder, a fixed annuity is generally an insurance product, not a security. Its guarantees depend on the insurer's claims-paying ability.

A real estate investment trust (REIT) that qualifies for favorable tax treatment must generally:

• a.Distribute a large majority of its taxable income to shareholders✓
• b.Avoid paying any dividends
• c.Invest only in government bonds
• d.Retain all of its income

A REIT must distribute a large majority of its taxable income, generally at least 90 percent, to shareholders to qualify for pass-through tax treatment. This produces relatively high dividend income for investors. REITs provide real estate exposure without direct property ownership.

An investor seeking exposure to a diversified basket of bonds with professional management and daily liquidity would MOST likely choose:

• a.A single corporate bond
• b.A bond mutual fund or bond ETF✓
• c.A private equity fund
• d.A collectible

A bond mutual fund or bond ETF offers a diversified, professionally managed portfolio of fixed-income securities with ready liquidity. A single bond lacks diversification, and private equity and collectibles are illiquid and unrelated. Pooled vehicles suit investors wanting broad bond exposure.

Treasury securities are generally considered to have virtually no:

• a.Default (credit) risk, because they are backed by the U.S. government✓
• b.Interest-rate risk
• c.Reinvestment risk
• d.Inflation risk

U.S. Treasury securities carry essentially no default risk because they are backed by the full faith and credit of the federal government. However, they remain exposed to interest-rate, reinvestment, and inflation risks. Investors accept lower yields for this credit safety.

A convertible bond gives the holder:

• a.A guaranteed equity dividend
• b.The right to force the issuer into bankruptcy
• c.The option to convert the bond into a specified number of the issuer's common shares✓
• d.Immunity from interest-rate risk

A convertible bond can be exchanged for a set number of the issuer's common shares, letting the holder participate in equity upside while receiving interest. This feature typically allows a lower coupon than a comparable straight bond. It blends debt and equity characteristics.

An investor writes a covered call. This strategy:

• a.Is purely a bearish bet
• b.Requires no ownership of the underlying
• c.Generates premium income while capping upside on the underlying shares owned✓
• d.Has unlimited downside beyond a naked position

Writing a covered call means selling a call against shares already owned, collecting premium income in exchange for capping potential upside if the stock rises above the strike. Because the position is covered by owned shares, risk is limited compared with a naked call. It suits a neutral to mildly bullish outlook.

A unit investment trust (UIT):

• a.Continuously issues and redeems shares at net asset value like an open-end fund
• b.Is run by a board of directors and an adviser that trade the portfolio actively
• c.Holds a fixed portfolio of securities and has a set termination date✓
• d.Is a corporation whose shares trade on an exchange at a premium or discount

A unit investment trust is an investment company that buys a fixed portfolio of securities and sells redeemable units against it, with a stated termination date when the trust dissolves and returns proceeds to investors. It has no board of directors and does not trade actively, it does not keep issuing units like an open-end fund, and it is not a corporation with exchange-traded shares like a closed-end fund.Investment Company Act of 1940 Sec. 4(2), 15 USC 80a-4(2)

Compared with corporate bonds, municipal bonds of similar credit quality typically offer:

• a.No credit risk at all
• b.Lower nominal yields, offset by federal tax-exempt interest✓
• c.Higher nominal yields with taxable interest
• d.Guaranteed federal insurance

Municipal bonds usually carry lower nominal yields than comparable corporates because their interest is generally exempt from federal income tax, raising the after-tax yield for taxable investors. They still carry credit and interest-rate risk. Taxable-equivalent yield comparisons are essential.

An equity-indexed (fixed-indexed) annuity typically credits interest based on:

• a.A guaranteed fixed rate with no market link
• b.Direct ownership of index shares
• c.A formula tied to an equity index, subject to caps, participation rates, or floors✓
• d.The performance of a single stock chosen by the client

A fixed-indexed annuity credits interest based on the performance of an equity index, but returns are limited by caps, participation rates, and protected by floors. The client does not directly own index securities. These features make its risk and return profile complex and require careful suitability review.

High-yield (junk) bonds are characterized by:

• a.Government backing
• b.Guaranteed principal repayment
• c.Lower credit ratings, higher yields, and greater default risk✓
• d.Investment-grade ratings and low default risk

High-yield bonds carry below-investment-grade ratings and compensate investors with higher yields to offset elevated default risk. They are more sensitive to economic downturns and issuer credit deterioration. Suitability requires a client who can tolerate this credit risk.

A money market fund seeks to:

• a.Guarantee a fixed return above inflation
• b.Preserve capital and provide liquidity by investing in short-term, high-quality debt✓
• c.Maximize capital appreciation through equities
• d.Provide leveraged exposure to commodities

A money market fund invests in short-term, high-quality debt instruments aiming to preserve principal and provide liquidity with modest income. It is not designed for capital appreciation and is not federally guaranteed. It suits cash-management needs within a portfolio.

A company has cumulative preferred stock and skips a dividend during a difficult year. Before the company may pay any dividend to common shareholders, it must:

• a.Pay the common dividend first, then make up the preferred arrears from later earnings
• b.Convert the preferred shares into common stock
• c.Redeem the preferred at par plus a call premium
• d.Pay all the omitted (in-arrears) preferred dividends✓

Cumulative preferred stock accrues any skipped (in-arrears) dividends, and those arrears must be paid in full before common shareholders receive any dividend. Paying common first reverses that priority. Conversion is a feature of convertible preferred, not of cumulative preferred. Redemption at a premium is a call feature that the issuer may exercise, not a condition for paying common dividends. Non-cumulative preferred, by contrast, simply loses a skipped dividend.

Participating preferred stock gives its holders the right to:

• a.Convert automatically into a fixed number of the issuer's common shares at maturity
• b.Force the issuer to repurchase the outstanding shares at par value at any time the holder chooses
• c.Vote on the same one-share-one-vote basis as common stockholders in all corporate elections
• d.Receive extra dividends beyond the fixed rate when earnings are strong✓

Participating preferred stock lets holders share in additional dividends above the stated fixed rate when the company performs well, over and above the regular preferred dividend. It is a way to give preferred holders some upside participation. Standard preferred receives only the fixed rate.

From the issuer's perspective, a corporation is MOST likely to call its callable preferred stock when:

• a.Market interest rates and dividend yields have risen substantially since the shares were issued
• b.Preferred holders demand that the issuer redeem their shares
• c.Market interest rates have fallen, letting it refinance at a lower cost✓
• d.The company's common stock has declined sharply in value on the open market recently

A corporation is most likely to call preferred stock when market rates have fallen, so it can redeem the high-cost shares and reissue at a lower dividend rate. Rising rates make the old, lower-rate preferred cheap to keep and a call pointless. A call is the issuer's right, so holders cannot compel redemption. A drop in the common stock price has no bearing on the refinancing economics.

A convertible preferred share with a par value of $100 is convertible into common stock at a conversion price of $25. The conversion ratio is:

• a.4 common shares per preferred share✓
• b.25 common shares per preferred share
• c.0.25 common shares per preferred share
• d.40 common shares per preferred share

The conversion ratio equals par value divided by the conversion price: $100 / $25 = 4 shares of common per preferred share. Knowing the ratio lets an investor compute the parity price and decide whether converting is worthwhile. The concept applies identically to convertible bonds.

A preemptive right granted to existing common stockholders allows them to:

• a.Vote their shares cumulatively, concentrating all of their votes on one director nominee
• b.Be paid ahead of bondholders from the company's assets if it is liquidated
• c.Inspect the company's books and records and receive annual financial statements
• d.Maintain proportional ownership by buying new shares before the public✓

A preemptive right lets current common shareholders buy newly issued shares in proportion to their existing stake before the shares are offered to the public, protecting them from dilution. Cumulative voting is a separate voting right. Stockholders rank behind bondholders in liquidation, so they are not paid ahead of them. Inspecting the books and receiving financial statements is a separate stockholder right that does nothing to protect against dilution.

A warrant attached to a new bond offering typically gives the holder:

• a.A right to convert the bond into the issuer's common stock at a stated ratio
• b.A long-term right to buy the issuer's stock at a set price, often initially above market✓
• c.A short-term right, expiring within weeks, to buy new shares at a discount to market
• d.A binding obligation to buy the issuer's stock at a preset price on a set future date

A warrant is a long-term right, often lasting years, to buy the issuer's stock at a fixed exercise price that is typically set above the market price when issued. Warrants are frequently used as a sweetener on bond or preferred offerings. A conversion right belongs to a convertible bond, which exchanges the bond itself for stock. The short-term, discounted right is a stockholder right in a rights offering. A binding obligation to buy at a set date is a forward contract.

An American Depositary Receipt (ADR) is BEST described as:

• a.A bond issued by a foreign government and denominated entirely in that country's local currency
• b.A negotiable receipt representing shares of a foreign company that trades in U.S. markets✓
• c.A pooled mutual fund that invests exclusively in emerging-market government debt securities
• d.A U.S. Treasury security whose principal value is adjusted for changes in the foreign exchange rate

An ADR is a negotiable certificate issued by a U.S. bank that represents shares of a foreign company, allowing those shares to trade in U.S. dollars on U.S. markets. It simplifies foreign investing but still carries currency (exchange-rate) risk. Dividends are received in dollars after conversion.

Cumulative voting, as compared with statutory voting, generally:

• a.Requires shareholders to split their votes equally among all open seats, with no option to concentrate them
• b.Gives each share one vote per seat with each seat voted on separately, which favors the majority holder
• c.Benefits minority shareholders by letting them concentrate all their votes on one director✓
• d.Is required by federal law for every publicly traded company, so every issuer must offer it to its shareholders

Cumulative voting lets a shareholder pool all votes (shares times open seats) and cast them for a single candidate, which helps minority holders elect at least one director. Splitting votes equally among all seats is the opposite of what the method allows. One vote per seat with each seat voted separately describes statutory voting, which favors the majority holder. Cumulative voting comes from state law and the corporate charter, not from a federal requirement.

Treasury stock refers to shares that:

• a.Are issued by the U.S. Treasury Department to finance the ongoing operations of the federal government
• b.The issuing company has repurchased and holds, carrying no votes or dividends✓
• c.Have been authorized in the corporate charter but have never actually been issued to any investor
• d.Represent a special class of preferred stock that is guaranteed by the federal government's credit

Treasury stock is stock that a corporation has issued and later reacquired; while held in treasury it has no voting rights and receives no dividends. It reduces the shares outstanding used in per-share calculations. It is unrelated to U.S. Treasury securities.

After a 2-for-1 stock split, an investor who held 100 shares priced at $80 each will have:

• a.200 shares worth $40 each, with total value unchanged✓
• b.50 shares worth $160 each
• c.100 shares worth $40 each, halving the position's total value
• d.200 shares worth $80 each

A 2-for-1 split doubles the share count and halves the price, so 100 shares at $80 become 200 shares at $40, leaving total value at $8,000 unchanged. A split changes the number and price of shares, not the investor's total value. Cost basis per share is adjusted accordingly.

The ex-dividend date is significant because an investor who buys shares on or after that date:

• a.Must also pay the seller the dividend
• b.Will still receive the dividend if the shares are held to the payment date
• c.Is not entitled to the upcoming declared dividend✓
• d.Is guaranteed the dividend if the trade settles before the payment date

On or after the ex-dividend date, a buyer is not entitled to the recently declared dividend; it goes to the seller who owned the shares before that date. The stock's price typically drops by roughly the dividend amount on the ex-date. To receive the dividend, an investor must buy before the ex-date.

The book value per share of common stock is calculated as:

• a.The current market price per share multiplied by the total number of shares outstanding
• b.Common stockholders' equity divided by common shares outstanding✓
• c.Total company assets divided by the combined number of preferred and common shares
• d.Annual earnings per share divided by the stock's current market price per share

Book value per share equals common stockholders' equity (net worth attributable to common) divided by common shares outstanding, giving an accounting measure of value per share. It often differs substantially from market price. Analysts compare price to book value to gauge valuation.

In a rights offering, the subscription price at which existing shareholders may buy new shares is typically:

• a.Equal to the par value of the common stock
• b.Below the current market price, giving the rights value✓
• c.Above the market price, to raise the most capital
• d.Exactly equal to the current market price on the distribution date

The subscription price in a rights offering is normally set below the current market price, which gives the rights intrinsic value and encourages shareholders to exercise or sell them. Par value is an accounting figure unrelated to the subscription price. A price above market would leave no reason to exercise. A price exactly at market would give the rights no value at issuance. Rights are short-term and trade separately.

The par value assigned to a share of common stock:

• a.Sets the dividend the company must pay, as a percentage of par
• b.Sets the floor price below which the exchange will halt trading and delist the stock
• c.Is the price at which the issuer must repurchase shares from holders on request
• d.Is an arbitrary accounting figure with little relation to market price✓

For common stock, par value is an arbitrary bookkeeping figure, often a penny or a few dollars, with essentially no relationship to market price. A dividend set as a percentage of par is a feature of preferred stock, not common. Exchanges do not set trading floors or delist based on par value. Issuers have no obligation to repurchase common shares at par or at any other price.

A bond with a 5% coupon (paying $50 annually) is currently trading at $1,250. Its current yield is:

• a.6.25%
• b.4%✓
• c.3.75%
• d.5%

Current yield equals the annual coupon divided by the current market price: $50 / $1,250 = 4%. Because the bond trades at a premium, its current yield (4%) is below its 5% coupon rate. Current yield ignores any gain or loss at maturity.

A bond is trading at a discount to par. Which ranking of its yields is correct?

• a.All three yields are exactly equal
• b.Current yield > yield to maturity > nominal yield
• c.Yield to maturity > current yield > nominal yield✓
• d.Nominal yield is greater than current yield, which is greater than yield to maturity

For a discount bond, yield to maturity is highest, followed by current yield, then the nominal (coupon) yield — the classic yield 'seesaw.' The discount adds capital appreciation at maturity, pushing YTM above the coupon. For a premium bond the order reverses.

For a bond purchased at a premium above par, the yield to maturity will be:

• a.Higher than both the current yield and the nominal (coupon) yield
• b.Between the current yield and the nominal yield, closer to the coupon
• c.Equal to the nominal yield, because the coupon is fixed for the life of the bond
• d.Lower than both the current yield and the nominal yield✓

A premium bond is redeemed at par, below the price paid, so the holder takes a built-in capital loss that pulls yield to maturity under both the current yield and the coupon rate: nominal yield > current yield > YTM. Yield to maturity higher than both is the discount-bond relationship, not the premium one. A yield between the two would ignore the capital loss, and YTM equals the coupon only for a bond bought at par.

U.S. Treasury bills are BEST described as:

• a.Inflation-indexed securities whose principal adjusts with the CPI
• b.Short-term instruments sold at a discount, paying no periodic interest✓
• c.Notes maturing in 2 to 10 years that pay a semiannual coupon
• d.Bonds with 20 to 30 year maturities that pay semiannual interest

Treasury bills are short-term obligations (one year or less) issued at a discount to face value; the return is the difference between the discounted price and par at maturity, with no periodic coupon. Inflation-indexed principal describes TIPS. Notes (2 to 10 years) and bonds (20 to 30 years) both pay semiannual interest.

Treasury Inflation-Protected Securities (TIPS) protect investors from inflation by:

• a.Guaranteeing a minimum real rate of return that is set by the Federal Reserve each year
• b.Allowing early redemption whenever inflation rises sharply
• c.Adjusting the bond's principal up or down with changes in the CPI✓
• d.Paying a fixed coupon plus a one-time cost-of-living bonus at final maturity

TIPS adjust their principal value with the Consumer Price Index, so the semiannual interest (a fixed rate applied to the adjusted principal) and the final payout rise with inflation. This preserves purchasing power. In deflation, the principal can adjust downward, though maturity payout is floored at the original par.

The lowest rating a bond can carry and still be considered 'investment grade' is:

• a.BB+, the highest speculative grade
• b.A-
• c.BBB- (Baa3)✓
• d.CCC

The lowest investment-grade rating is BBB- from Standard & Poor's (Baa3 from Moody's); anything below that is speculative or 'junk.' Many institutions are restricted to investment-grade bonds. Knowing this dividing line is essential for suitability and portfolio quality analysis.

A general obligation (GO) municipal bond is backed by:

• a.The full faith, credit, and taxing power of the issuer✓
• b.A private corporation's guarantee of any debt-service shortfall
• c.The revenue of a specific toll road or bridge
• d.Insurance provided by a U.S. federal agency

A general obligation bond is backed by the full faith, credit, and taxing power of the issuing municipality, which can levy taxes to make payments. A revenue bond, by contrast, is repaid only from a specific project's income. GO bonds are generally considered safer than revenue bonds of the same issuer.

Debt service on a municipal revenue bond is paid from:

• a.A reserve fund guaranteed by the U.S. Treasury
• b.Ad valorem property taxes levied by the municipality
• c.The general taxing authority of the state where the project is located
• d.The income produced by the specific facility it financed✓

A revenue bond is repaid solely from the income generated by the specific facility or project it financed, such as a toll bridge, airport, or utility. It is not backed by the issuer's general taxing power. Investors therefore analyze the project's projected revenues and coverage.

A debenture is a type of corporate bond that is:

• a.Secured by a pledge of the issuer's real estate and equipment
• b.Guaranteed by a third-party insurance company
• c.Collateralized by securities the issuer owns in other companies
• d.Backed only by the general credit of the issuer✓

A debenture is an unsecured corporate bond backed only by the general credit and full faith of the issuer, with no specific collateral pledged. Investors rely on the company's overall creditworthiness. Secured bonds, such as mortgage bonds, are instead backed by specific assets.

An investor holding a callable bond faces the greatest risk that the bond will be called when:

• a.The issuer's credit rating has recently been downgraded
• b.The stock market has entered a prolonged decline
• c.Interest rates have risen above the coupon
• d.Interest rates have declined below the coupon✓

Issuers call bonds when market rates fall below the bond's coupon, letting them refinance at a lower cost — leaving the investor to reinvest at lower prevailing rates (call and reinvestment risk). Rising rates make a call unlikely. Call features usually include a set period of call protection.

When a corporate bond is purchased in the secondary market between interest payment dates, the buyer generally pays the seller:

• a.The quoted price minus the interest accrued since the last payment date
• b.A price reduced by the full next coupon payment
• c.The quoted price plus interest accrued since the last coupon✓
• d.Only the quoted price, with no adjustment for interest

The buyer pays the bond's price plus accrued interest — the interest earned by the seller since the last coupon date — because the buyer will receive the full next coupon. Most corporate and municipal bonds accrue on a 30/360-day basis. This compensates the seller for the interest earned while holding.

Government National Mortgage Association (GNMA / Ginnie Mae) pass-through securities:

• a.Pay interest that is entirely exempt from federal, state, and local income taxation for holders
• b.Pass through monthly principal and interest, with a U.S. government guarantee✓
• c.Return the entire principal in one lump sum at a fixed maturity date
• d.Carry only an implied government backing, as Fannie Mae securities do

Ginnie Mae pass-throughs distribute monthly payments of principal and interest from a pool of mortgages, and the timely payment is backed by the full faith and credit of the United States. Their interest is fully taxable, so it is not exempt like municipal interest. They amortize monthly rather than paying principal in a lump sum, and unlike Fannie Mae and Freddie Mac securities the backing is an explicit guarantee, not an implied one. Because homeowners can prepay, holders face prepayment risk.12 U.S.C. 1721(g)

Interest income received from a corporate bond is generally:

• a.Taxed at the long-term capital gains rate
• b.Tax-free if reinvested
• c.Exempt from federal tax but subject to state and local tax
• d.Fully taxable as ordinary income✓

Corporate bond interest is fully taxable as ordinary income at the federal, state, and local levels. This contrasts with municipal bond interest (generally federally tax-exempt) and Treasury interest (exempt from state and local tax). After-tax yield comparisons are central to suitability.

A resident of a state who buys a municipal bond issued within that same state generally receives interest that is:

• a.Taxed only at the local municipal level
• b.Exempt from federal and that state's income tax✓
• c.Fully taxable at every level
• d.Subject to federal income tax but exempt from that state's income tax

Interest on a municipal bond is generally exempt from federal income tax, and when the investor resides in the issuing state, it is usually also exempt from that state's income tax (often called 'triple tax-exempt' when local taxes also do not apply). Out-of-state munis are typically federally exempt but state-taxable.

An investor in the 32% federal tax bracket is considering a municipal bond yielding 4%. The taxable-equivalent yield is approximately:

• a.12.5%
• b.4.32%
• c.2.72%
• d.5.88%✓

Taxable-equivalent yield equals the tax-free yield divided by (1 minus the tax bracket): 4% / (1 - 0.32) = 4% / 0.68 = 5.88%. A taxable bond would need to yield about 5.88% to match the muni after tax. Higher brackets make municipal bonds relatively more attractive.

A corporate bond yields 6% and the investor is in the 25% tax bracket. The investor's approximate after-tax yield is:

• a.6.00%
• b.8.00%
• c.1.5%
• d.4.5%✓

After-tax yield equals the taxable yield times (1 minus the tax bracket): 6% x (1 - 0.25) = 4.5%. This is the yardstick for comparing a taxable corporate bond against a tax-free municipal bond. Here a muni yielding more than 4.5% would be the better after-tax choice.