yield equivalence

Yield Equivalence

The interest rate on a taxable security that would render a return equivalent to that of a tax-exempt security, and vice versa.

Notes:

In order to calculate yield equivalence, divide the tax-exempt yield by 1 minus the investor's tax rate. For example, say you were considering a 6% tax-exempt municipal bond, but you would like to calculate what the interest rate on a taxable investment would have to be to give you the same return. If you have a 20% rate of taxation, you would need a return of 7.5% on your taxable investment to match the 6% return on the tax-exempt investment (6%/(1-0.20)=7.5%).

Conversely, if you know your taxable rate of return, you can calculate the equivalent rate on a tax-exempt investment. This is done by multiplying the taxable rate by 1 minus the your tax rate. If your taxable return is 6% and your rate of taxation is 20%, you need a 4.8% return on a tax-exempt security to match the after-tax return on a taxable security (6%*(1-0.20)=4.8%).

See also: Bond, Municipal Bond, Yield

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Yield equivalence

The interest rate at which a tax-exempt bond and a taxable security of similar quality give the investor the same rate of return.

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yield equivalence

Equal aftertax returns on different investments. As an example, for an investor in a 25% marginal tax bracket, a corporate bond with a taxable return of 8% has yield equivalence with a tax-free bond returning 6%.