What is ‘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:
Explaining ‘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%).
Further Reading
- The US Treasury yield curve: 1961 to the present – www.sciencedirect.com [PDF]
- Financial opening, deposit insurance, and risk in a model of banking competition – www.sciencedirect.com [PDF]
- Forecasting the term structure of government bond yields – www.sciencedirect.com [PDF]
- The cost of capital, corporation finance and the theory of investment – www.jstor.org [PDF]
- Money in the utility function: functional equivalence to a shopping-time model – www.sciencedirect.com [PDF]
- What drives provincial‐Canada yield spreads? – onlinelibrary.wiley.com [PDF]
- Reverse engineering the yield curve – www.nber.org [PDF]
- Why Gaussian macro-finance term structure models are (nearly) unconstrained factor-VARs – www.sciencedirect.com [PDF]
