Calculations:

A. If Kaili and Taylor use the principal and interest for tuition, the bond is both federal and state tax-exempt. The formula is:

Return after tax = return before tax * (1 – tax rate)

 Since this asset is federal and state tax-free, the equivalent yield on a taxable bond would be the tax-free return divided by 1 minus the tax rate, which includes both federal and state taxes (mathematically, you divide both sides of the equation by (1 – tax rate))

4.8% = x *(1 – (.25+.07)) or x = 4.8% / .68

 x = 7.06%

 B. If Kaili and Taylor use the  principal and interest for a family vacation, it is only state tax free. The equivalent yield on a taxable bond would be:

 The tax-free rate:

 Tax-free rate = 4.8% * (1 - .25) or 3.6%

 The equivalent taxable yield is

ETY = 3.6% / (1 – (.25 + .07))

x = 5.29%