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. Capital Gain

    1. An increase in the value of a capital asset (investment or ...
  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. Bond

    A debt investment in which an investor loans money to an entity ...
  5. Municipal Bond

    A debt security issued by a state, municipality or county to ...
  6. Tax-Exempt Interest

    Interest income that is not subject to federal income tax. Tax-exempt ...
Related Articles
  1. The Basics Of Municipal Bonds
    Bonds & Fixed Income

    The Basics Of Municipal Bonds

  2. Do Money-Market Funds Pay?
    Options & Futures

    Do Money-Market Funds Pay?

  3. Weighing The Tax Benefits Of Municipal ...
    Taxes

    Weighing The Tax Benefits Of Municipal ...

  4. Bond Basics Tutorial
    Retirement

    Bond Basics Tutorial

Hot Definitions
  1. Leading Indicator

    A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators ...
  2. Wage-Price Spiral

    A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. ...
  3. Accelerated Depreciation

    Any method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier years ...
  4. Call Risk

    The risk, faced by a holder of a callable bond, that a bond issuer will take advantage of the callable bond feature and redeem ...
  5. Parity Price

    When the price of an asset is directly linked to another price. Examples of parity price are: 1. Convertibles - the price ...
  6. Earnings Multiplier

    An adjustment made to a company's P/E ratio that takes into account current interest rates. The earnings multiplier is used ...
Trading Center