Yield Equivalence

AAA

DEFINITION of '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, calculated as follows:

Yield Equivalence

INVESTOPEDIA EXPLAINS 'Yield Equivalence'

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 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%).

RELATED TERMS
  1. Bond

    A debt investment in which an investor loans money to an entity ...
  2. Yield

    The income return on an investment. This refers to the interest ...
  3. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
  4. Tax Exempt

    To be free from, or not subject to, taxation by regulators or ...
  5. Capital Gain

    1. An increase in the value of a capital asset (investment or ...
  6. Tax Rate

    The percentage at which an individual or corporation is taxed. ...
RELATED FAQS
  1. How does inflation affect a company's short-term investments?

    Inflation marginally erodes a company's short-term investments. Short-term investments are typically ultra-safe liquid assets, ... Read Full Answer >>
  2. Why would an investor consider purchasing electronic stocks for their portfolio?

    An investor would consider purchasing electronics stocks because that sector provides many opportunities for both quick profits ... Read Full Answer >>
  3. Other than my savings account, what other types of holdings compound my interest?

    Investors and savers can use the power of compounding interest to accumulate wealth over time. Unlike simple interest that ... Read Full Answer >>
  4. What is the difference between a term and open repurchase agreement?

    The major difference between a term and an open repurchase agreement (repo) is in the term or tenor. In a term repo, the ... Read Full Answer >>
  5. Which asset classes are the most risky?

    Equities is the riskiest class of assets. Dividends aside, they offer no guarantees, and investors' money is subject to the ... Read Full Answer >>
  6. How is the interest rate on a treasury bond determined?

    The yield of U.S. Treasury securities, including Treasury bonds (T-bonds), depends on three factors: the face value of the ... Read Full Answer >>
Related Articles
  1. Bonds & Fixed Income

    The Basics Of Municipal Bonds

    Investing in these bonds may offer a tax-free income stream but they are not without risks.
  2. Options & Futures

    Do Money-Market Funds Pay?

    This investment provides security, but its returns may not be adequate for long-term investors.
  3. Taxes

    Weighing The Tax Benefits Of Municipal Securities

    Find out how to determine whether the tax exemption offered by "munis" benefits you.
  4. Retirement

    Bond Basics Tutorial

    Investing in bonds - What are they, and do they belong in your portfolio?
  5. Trading Strategies

    Are These the Top Monthly Dividend Stocks?

    Interested in monthly dividends? Here are two stocks to watch.
  6. Professionals

    Beware: These Bond Funds Act Like Stocks

    Beware of bond funds that act like stocks.
  7. Investing

    Three Portfolio Moves To Consider Now

    What portfolio moves should you consider making as the 2nd quarter kicks off? Before we focus on the future, let’s first reflect on the 1st Q surprises.
  8. Mutual Funds & ETFs

    Pros & Cons Of Bond Funds Vs. Bond ETFs

    Understanding the pros and cons of bond funds and bond ETFs will help you choose the instrument that is best for building your diversified bond portfolio.
  9. Mutual Funds & ETFs

    Pros and Cons: Preferred Stock ETFs vs. Bond ETFs

    A look at the differences between preferred stock ETFs and bond ETFs and when you should invest in one over the other.
  10. Bonds & Fixed Income

    African Sovereign Debt: Risks and Rewards

    African sovereign debt offers high yields and upside — if one has the stomach for the risk.

You May Also Like

Hot Definitions
  1. Adverse Selection

    1. The tendency of those in dangerous jobs or high risk lifestyles to get life insurance. 2. A situation where sellers have ...
  2. Wash Trading

    The process of buying shares of a company through one broker while selling shares through a different broker. Wash trading ...
  3. Fixed-Income Arbitrage

    An investment strategy that attempts to profit from arbitrage opportunities in interest rate securities. When using a fixed-income ...
  4. Venture-Capital-Backed IPO

    The selling to the public of shares in a company that has previously been funded primarily by private investors. The alternative ...
  5. Merger Arbitrage

    A hedge fund strategy in which the stocks of two merging companies are simultaneously bought and sold to create a riskless ...
  6. Market Failure

    An economic term that encompasses a situation where, in any given market, the quantity of a product demanded by consumers ...
Trading Center