A comparison of yield between taxable bonds selling at par and tax-exempt bonds selling at a discount. A corporate bond yields less than its stated interest rate because of taxation, whereas a tax-exempt municipal bond does not. Thus, a municipal bond paying a lower interest rate will often net the bondholder more than a corporate bond with a slightly higher interest rate, depending upon one's tax bracket. The corporate equivalent yield measures how much this difference is. See also: Municipals-over-bonds spread.
The yield that would need to be realized on a taxable bond selling at par in order to achieve the same aftertax yield to maturity of a bond selling at a premium or discount. For example, a $1,000 par, 10% coupon bond that sells for $900 and is due to mature in five years would provide a yield to maturity of 12.8%. However, after taxes have been paid at a rate of 28% on the $100 gain ($1,000 - $900) and 28% on the $100 annual interest payments, the aftertax yield to maturity is slightly under 10%. The corporate equivalent yield is 0.1/(1 - 0.28), or 13.9%.