After-tax yield represents the actual return on an investment after accounting for taxes.
Which of the following investments is most likely to have a higher after-tax yield for an investor in a high tax bracket?
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A) Taxable corporate bonds are subject to taxes, which can reduce their after-tax yield for high-income investors. B) Tax-exempt municipal bonds are not subject to federal income taxes, making them more attractive for high-income investors. C) Tax-deferred annuities postpone taxes until later but do not eliminate them. D) Stocks with high dividend yields may be subject to taxes on dividend income, reducing their after-tax yield.
How can an investor calculate the taxable equivalent yield of a tax-exempt investment?
A) Multiplying the tax-exempt yield by the investor's tax rate would result in a lower yield, not the taxable equivalent yield. B) Dividing the tax-exempt yield by the investor's tax rate would result in a higher yield but not the taxable equivalent yield. C) Multiplying the tax-exempt yield by (1 - the investor's tax rate) would result in a lower yield, not the taxable equivalent yield. D) Dividing the tax-exempt yield by (1 - the investor's tax rate) provides the taxable equivalent yield, allowing for comparison with taxable investments.
Which type of tax is most relevant when considering the after-tax yield of a fixed-income investment?
A) Capital gains tax is relevant for investments that appreciate in value but is less relevant for fixed-income investments that primarily generate interest income. B) Interest income tax directly affects the after-tax yield of fixed-income investments, as it is applied to the interest earned from these investments. C) Dividend income tax is relevant for stocks that pay dividends, not fixed-income investments. D) Estate tax is relevant for transferring assets upon death but does not directly affect the after-tax yield of fixed-income investments.
In the 1980s, municipal bonds became increasingly popular among high-income investors due to their tax-exempt status. This led to a surge in demand for these bonds, driving their prices and lowering their yields. As a result, many investors began to compare the after-tax yields of municipal bonds to those of taxable bonds to determine which investment offered the best return.
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Example Series 65 Example Practice Question
An investor in the 35% tax bracket is considering two bond investments: a taxable corporate bond with a yield of 6% and a tax-exempt municipal bond with a yield of 4%. To compare the after-tax yields, the investor calculates the taxable equivalent yield of the municipal bond: 4% / (1 - 0.35) = 6.15%. In this case, the municipal bond offers a higher after-tax yield than the corporate bond.
After-tax Yield = Taxable Yield * (1 - Tax Rate)
An investor has a taxable yield of 6% on a fixed-income investment and is in the 25% tax bracket. Calculate the after-tax yield. 1. Identify the taxable yield: 6% 2. Identify the tax rate: 25% 3. Calculate the after-tax yield: 6% * (1 - 0.25) = 6% * 0.75 = 4.5% The after-tax yield is 4.5%.