The after-tax yield is the yield on a taxable bond after federal income taxes are paid. It is computed with the following formula.
|After-tax yield = pre-tax yield x (1- marginal rate)|
The marginal rate will vary depending on the tax bracket the investor is at that given time.
Example: Taxable Bond Yield
Taxable bond yield is 7.5%
The Marginal tax rate for this investor is 31%
After-tax yield = .075 x (1-.31)
The tax-equivalent yield is the yield that must be offered on a taxable bond issue to give the same after-tax yield as a tax-exempt issue. It is computed with the following formula.
|Taxable-equivalent yield = tax-exempt yield / (1- marginal tax rate)|
Example: Tax-Exempt Yield
Tax exempt yield = 5.00%
Marginal Tax Rate = 31%
Taxable-equivalent yield = .05 / (1-.31)
= .05 / .69
= 7.2464 %
This means that a taxable issue must yield more than 7.25 % for the investor at the 31% tax bracket in order to beat the 5% yield offer in the tax-exempt bond.
Notice that the higher the marginal tax rate, the higher the taxable equivalent yield would be needed in the taxable bond market.
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