Yield Equivalence

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

BREAKING DOWN '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. Tax-Exempt Interest

    Interest income that is not subject to federal income tax. Tax-exempt ...
  2. Tax-Exempt Security

    A security in which the income produced is free from federal, ...
  3. Fully Taxable Equivalent Yield

    The yield on a municipal bond, when the effect of reduced taxes ...
  4. Tax-Exempt Sector

    The market niche comprised of investment vehicles exempt from ...
  5. After-Tax Basis

    A comparison of the net yields produced by taxable and tax-exempt ...
  6. Taxable Municipal Bond

    A fixed-income security issued by a local government such as ...
Related Articles
  1. Managing Wealth

    3 Money Market Funds for High Net Worth Investors (VMSXX, PTEXX)

    Explore analyses of three tax-exempt money market funds that may be suitable for high net worth investors, and learn about the characteristics of these funds.
  2. Personal Finance

    Ten Things That You Might Not Know Are Taxable

    When you file your taxes this year make sure that you have claimed all taxable income. Here are ten things that you might not know are taxable
  3. Personal Finance

    Taxation Rules For Bond Investors

    Several factors affect the taxable interest that must be reported. Learn more here.
  4. Retirement

    3 Tax-Reduction Strategies for High-Net-Worth Investors

    Learn about three tax strategies that reduce taxable income and minimize the share of taxes paid on employer-sponsored and individual investment accounts.
  5. Retirement

    Not All Retirement Accounts Should Be Tax-Deferred

    It may be better to leave your assets exposed to the tax man when you're saving to retire.
  6. ETFs & Mutual Funds

    Top 3 Mutual Funds from American Funds' Tax Exempt Bond (LTEBX, ABHFX)

    Explore American Funds' mutual fund offering to identify three well-rated tax-exempt bond funds. Learn about risk-adjusted returns and fees of each fund.
  7. Markets

    What are Cash Equivalents?

    Cash equivalents are money market instruments.
  8. Personal Finance

    Weighing The Tax Benefits Of Municipal Securities

    Find out how to determine whether the tax exemption offered by "munis" benefits you.
  9. Financial Advisor

    How to Optimize Taxable Portfolios in Bear Markets

    A bear market presents an opportunity for financial advisors to optimize clients' taxable portfolios.
  10. Markets

    Calculating Bond Equivalent Yield

    The bond equivalent yield calculates the semi-annual, quarterly or monthly yield on a discount bond or note.
RELATED FAQS
  1. Are my 2015 unrealized capital gains and dividends on mutual funds taxable income?

  2. What are the best free online calculators for calculating my taxable income?

    Find out where to locate the best online calculators to determine your taxable income and why it is important to know this ... Read Answer >>
  3. Why should I keep records on my tax-exempt bond transactions?

    Keep your purchase records on all investments, including tax-exempt bonds. Though the interest is tax-free, you may owe taxes ... Read Answer >>
  4. Are Social Security benefits taxable?

    Find out what rules and guidelines govern if your social security benefits are taxable. Learn how to determine if you are ... Read Answer >>
  5. Dennis, a resident of Pennsylvania, bought a U.S. Treasury Bond which pays 7% interest ...

    The correct answer is d) The interest from U.S. Treasury Bonds is exempt from state and local taxes, however; it is subject ... Read Answer >>
  6. An investor is in the 36% tax bracket and holds municipal bonds with an 8% yield-to-maturity. ...

    A. 8.0%B. 22.2%C. 9.3%D. 12.5% Correct answer: D "A" divides 1-minus-tax-rate by the tax-exempt yield, instead of vice versa, ... Read Answer >>
Hot Definitions
  1. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  2. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  3. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  4. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  5. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  6. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
Trading Center