Equations

Question 1

TEY

Taxable Equivalent Yield

(TEY)

Answer 1

• TEY of the muni bond
• Used to compare the advisability of investing in municipal, tax-exempt issues to taxable, corporate issues

TEY = tax-exempt yield

1 - marginal tax rate

Example:

• Kate owns a muni bond
• 3% coupon rate
• 32% federal marginal tax bracket
• TEY = 3/1-.32 = 4.41%*
• Therefore, t_o achieve the same yield on a taxable corporate bond,_ the corporate bond must have a coupon rate of at least 4.41%.*

Question 2

After-Tax Yield

(ATY)

Answer 2

• ATY of the taxable corporate bond
• Compare advisability of investing in taxable issues with that of investing in muni tax-exempt issues

After-Tax Yield = (pretax return) X (1-marginal tax rate)

For a _taxable corporate bond_ that yields 4.35%, the after-tax yield to an investor with a 35% marginal tax rate is 2.83%.

ATY = (4.35%) X (1-.35)

= (4.35%) X (0.65)

= 2.8275 or 2.83%

Question 3

For annuity payments

Exclusion Ratio

Answer 3

Exclusion Ratio = the amount of monthly payout that is a return of principal, therefore not taxed. The remainder is OI taxed.

Exclusion Ratio = Investment/Expected Return

Expected Return = (Monthly Payment) X (Life Expectancy in Months)

Exclusion ratio is applied until annuitant recovers entire principal; then full payment is taxable.

Question 4

For annuity payments

Inclusion Ratio