FGR Bond Investment - Essay Example

Taxable Equivalent Yield Insert Introduction It is also an equivalent taxable interest rate. It is that returns on the taxable investment to make it same as the return on a tax-exempt investment. The use of taxable equivalent yield is when evaluating municipal bond returns. It is also a type of concept that helps one to determine either to invest in taxable or tax-free bonds that is the calculation of the taxable equivalent yield. Such returns would be needed to be earned from a taxable bond to generate the same after-tax return as a tax-free bond.

To compare between a taxable and tax-exempt bonds, one has to compare bonds with the same credit ratings and time to maturity (Pogue, 2010). The bond that is a tax-free with a high credit rating and a 4.7% taxable equivalent yield is much safer investment than that taxable bond that pays 5 % with a low credit rating. As a result, advisable that one does not need to buy tax-exempt bonds for him just to get the tax-free income if he is in a lower tax bracket.How Taxable Equivalent Yield works Its formulae are: R (te) = R (tf) /(1- t) Where by: R(te) = taxable equivalent output for the investor R(tf) = return on tax-free investment (usually it is a municipal bond) t = investor’s marginal tax rateIn the given test, we can have its solution as;With the DES corporate bond, the yield that the investor receives is taxable at 30%.

With the FGR municipal bond, the yield is tax-free. As a result, in order to compare the two options, one has to figure out the taxable-equivalent yield of municipal bond. First, one has to find out what he keeps from taxable investments, which, in this case, is 70% or .70 of the taxable yield. Since the investor pays 30% of every dollar in taxes, he gets to keep 70%.1 (your tax bracket of 30%) = .70Next, take the tax-exempt yield of 9% and divide it by .70.9% divided by .70 =12.8571%12.9% (rounded up from 12.8571) is the taxable-equivalent yield of 9% corporate bond if you are in the 30% tax bracket.

It is, as a result, obvious that this is more than the FGR’s municipal bond taxable rate of 7%. That is; one can conclude that if you were to earn 12.9% and pay 30% on the interest, one would end up with 9% after-tax yield. As a result, Beth who is an investor in this case in the 30% tax bracket would choose Options 1 for it is because the higher taxable-equivalent yield would give the most appealing income stream.The importance of municipal bonds is that, the interest received from it is free from federal income taxes thus making it free from state income taxes.

As with municipal bonds, everything comes down to taxes. If one is not benefiting from tax-exemption, he will earn more with taxable bonds. However, based on one’s tax bracket, the tax-free municipal bond that has a lower yield may offer a higher after-tax return compared to the higher-yielding taxable Treasury bonds.ReferencesPogue, M. (2010). Corporate investment decisions. [New York, N.Y.] (222 East 46th Street, New York, NY 10017): Business Expert Press.