If an investor can buy-and-hold a tax advantage (i.e., tax exempt) security that
ID: 2750149 • Letter: I
Question
If an investor can buy-and-hold a tax advantage (i.e., tax exempt) security that yields 4.5% and faces a marginal tax rate of tax rate of 30%, what rate of return must be earned on a taxable investment to match the tax-exempt yield?
f your portfolio is comprised of 50% common stock, 30% bonds and the remainder in money market funds, what is your expected annual return for the entire portfoli if the rate of return for each of investment class is:
11% for common stocks, 4.5% for bonds and 2% for money market funds.
Explanation / Answer
1. Yield earned on the taxable security = Yield on tax exempt security / (1- tax)
Yield earned on the taxable security = 4.5% / (1-30%) = 6.43%
2. Portfolio annual return = sum of (Weight of security * security return)
Portfolio return = 50% * 11% + 30% * 4.5% + 20% * 2.0% = 7.25%