Definition of Tax-Equivalent Yield

Tax-equivalent yield is the yield that must be offered before giving taxes to pay off an after tax yield. It is used to compare tax free and taxable investments as tax free investments have less pretax yields.

Explanation of Tax-Equivalent Yield

Formula to calculate tax equivalent yield is as follow:

Tax Equivalent Yield = Tax Free Yield / (1 – Tax Rate)

Municipal bond is the most common example of tax-free investment. These bonds are issued by the local government to finance the improvement/ development of local society. Mostly, the investors who lie in high tax bracket tend to invest in municipal bonds as this is a tax-free investment.