CFA Practice Question

CFA Practice Question

Assume the following information about a corporate debt security and a municipal security:

Corporate Security A:
Coupon rate: 7.25% per year
Yield: 9.66% per year
Municipal Security B:
Coupon rate: 4.75% per year
Yield: 5.05% per year
Marginal Tax Rate: 36%

Using this information, what is the after-tax yield on the corporate debt security? Further, what is the yield ratio between the after-tax yield on the corporate debt security and the yield on the municipal security?
A. 6.18%, 1.22
B. 6.18%, 1.44
C. 4.64%, 1.09
Explanation: To compute the after-tax yield on a taxable debt security, use the following equation:
{After-tax yield = [Yield * (1 - marginal tax rate)]}
Imputing the given information into this equation will yield the following:
{After-tax yield = [0.0966 * (1 - 0.36)] = 0.061824}, or 6.18%

To determine the yield ratio between the after-tax yield on the corporate debt security and the tax-free yield on the municipal security, use the following equation:
{Yield ratio between two debt issues = [Yield on issue A / Yield on issue B]}, where the yield on issue A is greater than the yield on issue B.
Imputing the given information into this equation will yield the following:
(Yield ratio = [0.0618 / 0.0505] = 1.223762}, or 1.22

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