There was question asking to compute the yield ratio between a tax exempt bond and the treasury. Shouldn’t the larger yield go in the numerator so that you have a number larger than 1? They don’t show that being the case in the answers/feedback
in this case, the bond with the higher bond equiv yield goes in the numerator…even though it looks like the lower yield…in fact it has the higher yield. I think that’s why they first ask us to adjust the muni bond to a BEY.
actually, when comparing bonds to tsy bonds, you will put the tsy bond a the denominator and you will not adjust for tax equivalent yields.
I thought that was the case too, but according to the text on page 353, the denominator is the reference yield… usually the treasury. In this example, it just happens that the reference yield is greater than the muni. But in almost all cases, the numerator would be greater. This is a VERY GOOD THING TO REMEMBER!!! I must have gotten this wrong on the test, because I had the inverse!
yep, i see that now… Guess there were no examples of this anywhere.
yah, in all cases other than when we are comparing a bond to a treasury bond, we will calculate the yield ratio as being the higher yield/lower yield. when comparing a bond yield to a tsy bond yield, the tsy bond WILL be the denominator.
What I wrote wasn’t clear, and I’ll be the first to admit that y’all understand better than I do. Indeed, if we see it on the test this saturday, it is very likely that we’ll see a corporate bond / treasury bond, specifically higher yield divided by the lower yield, and they may combine the question with an absolute yield question, too, or maybe a relative yield.
It is a big thing in muni world to figure out what % munis are trading of treasuries. People start crossing selling/buying (buying more tax exempts or taxables, depending…)if munis are a large % of treasuries depending on tax rates. That is why this is important.
so technically the formula for yield ratio is : higher yield/lower yield. What is the consensus on why the mock exam q ended up being lower yield/higher yield? I’m having trouble following ?
Put the treasury in the denominator, it is the default to compare it to. That is what I have figured out. If you have a corp to compare it too, ylds. are normally higher than treasuries b/c they are taxable. If you have a muni, ylds are usually lower than treasuries b/c they are tax exempt and investors do not demand such a high yld.
Actually I think it is using the Higher Yield/Lower Yield to get the right answer. When you adjust the higher taxable yield to match the tax exempt, it is actually less.
you also need to adjust the demoinator too I believe for the extra 100 BP