Financial Risk Manager Part 2

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Explanation:

The correct answer is C.

\text{TEY} = \frac{\text{After-tax return on a tax-exempt investment}}{(1 - \text{Investing firm's marginal tax rate})}

Recall that municipal bonds are tax-exempt; thus, the expected after-tax gross returns for Aaa-rated municipal bonds will be:

$`$ 5`% \times (1 - 0) = 5%

\text{TEY} = \frac{5%}{(1 - 0.35)} = 7.69%

This measure means that the Aaa-rated corporate bond and the prime-rated loans would have to have a before-tax yield of 7.69% to match the Aaa-municipal bond’s after-tax yield of 5.0%.

Q.3863 Suppose that Aaa-rated corporate bonds have an average gross yield to maturity of 8%, the prime rate on top-quality corporate loans is 6%, and Aaa-rated municipal bonds have a 5% gross yield to maturity. Calculate the tax-equivalent yield (TEY) for the Aaa-rated municipal bonds for a taxed financial firm in the top 35% federal income tax bracket.

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Last updated: July 5, 2026 at 07:08

5.00%

6.52%

7.69%

14.29%