First, think about the way in which interest on municipal bonds is treated from a federal income tax point view. In this light, approximately what interest rate would a taxable bond have to offer to make its yield equivalent to that of a municipal bond that has an interest rate of 3.5% if a person in a 22% tax bracket?

4% (exactly 4.4%)

Explanation:

A taxable bond is a debt security whose return to the investor is subject to taxes at the local, state or federal level, or some combination thereof. An investor trying to decide whether to invest in a taxable bond or tax-exempt bond should consider what s/he will have left in income after taxes are taken.

Step 1:

Find the reciprocal of your tax rate,

(1-22%) = 1-0.22 = 0.78

Step two:

Divide this into the yield on the tax-free bond to find out the tax-equivalent yield.

3.5/0.78 = 4.4 ~ 4%

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