Tax equivalent question

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noseykibitzer

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investor in 28% tax bracket buys a 20 year 4% muni for $750. What is the bond's tax equivalent yield?

1) 5.56%
2) 6.22%
3) None of these are correct
4) 9.62%
 
I tried to figure it this way

PMT = 20
FV = 1000
PV = -750
N = 40
compute I/Y = 3.09892

BEY = 6.1978

TEY = Tax Free/(1-tax rate) = 6.1978/.72 = 8.612%

C is the right answer but for all the wrong reasons which I don't understand

This thing says that you can't find the tax equivalent yield because it only works for bonds trading at par....any ideas about that.?
 
oops, I overlooked the fact its not trading at par!

Then C would be the answer, but no, I wasn't aware that you can't find tax equivalent yeilds for bonds not selling at par.
 
Too bad Schweser doesn't say anything about this not working for a bond not trading at par in the notes (at least I don't remember them making note of that).

I would've chosen A...

tax-free yield (muni)/(1-tax rate)
0.04/0.72 = 0.055555 ~= 5.56%

I guess it makes sense though, considering the bond is at a discount and you're trying to find the parity yield that makes them equal factoring in taxes? This is such a bullsh!t question that they've worded poorly.

If you can't find tax-equvalent yields for bonds trading at anything other than par, they should've said, can't be determined or something instead of giving the impression that it would produce a yield/percentage higher or lower than what is listed in the choices. I guess I'll have to be watching out for more tricks?
 
If the yield is 4% then the answer is 5.556, but other NB is one the right track.
 
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