Tax equivalent yield: Difference between revisions
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<li>[[ | <li>[[Required rate of return]]</li> | ||
<li>[[Net yield]]</li> | |||
<li>[[Free cash flow yield]]</li> | <li>[[Free cash flow yield]]</li> | ||
<li>[[Net | <li>[[Net present value (NPV)]]</li> | ||
<li>[[ | <li>[[Market Risk Premium]]</li> | ||
<li>[[Tax preference theory]]</li> | <li>[[Tax preference theory]]</li> | ||
<li>[[ | <li>[[Nominal rate of return]]</li> | ||
<li>[[Dividend]]</li> | <li>[[Dividend per share]]</li> | ||
<li>[[ | <li>[[Blended Rate]]</li> | ||
</ul> | </ul> | ||
}} | }} | ||
The '''tax-equivalent yield''' is the pre-tax yield that a taxable '''[[bond]]''' must have to be equal to that of a tax-free municipal bond for its value. This equation can be used to equate a tax-free bond's yield equally with a taxable bond's yield to see which bond has a higher yield. It is also known as '''the yield after tax'''<ref>R. C. Marston, 2014, p. 139</ref>. | The '''tax-equivalent yield''' is the pre-tax yield that a taxable '''[[bond]]''' must have to be equal to that of a tax-free municipal bond for its value. This equation can be used to equate a tax-free bond's yield equally with a taxable bond's yield to see which bond has a higher yield. It is also known as '''the yield after tax'''<ref>R. C. Marston, 2014, p. 139</ref>. | ||
Revision as of 00:35, 20 March 2023
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The tax-equivalent yield is the pre-tax yield that a taxable bond must have to be equal to that of a tax-free municipal bond for its value. This equation can be used to equate a tax-free bond's yield equally with a taxable bond's yield to see which bond has a higher yield. It is also known as the yield after tax[1].
Consideration of the tax implications of investing in municipal bonds is important for investors. Because the interest earned from municipal bonds is tax-free federally, municipal bonds will offer a lower rate than other similar quality bonds. Although the rate is often much lower, the investor may still be better off with the lower municipal rate than with a higher corporate bond rate. Investors in a higher tax bracket will benefit from the tax exemption more than investors in a lower tax bracket. To ascertain where an investor would be better off after taxes, it's good to look to the tax-equivalent yield[2].
The Tax equivalent yield Formula
Look at the tax-equivalent yield calculated using the following formula to determine where an investor would be better off after taxes[3]:
Example of The Tax equivalent yield
A good example is presented by The Securities Institute of America and it reads as follows: "Take an investor considering purchasing a municipal bond with a coupon rate of 7 %. The investor is also considering investing in a corporate bond instead. The investor is in the 30% federal tax bracket and wants to determine which bond is going to give the greatest return after taxes.
In this example[4]:
- if the corporate bond of similar quality does not yield more than 10 %, then the investor will be better off with the municipal bond
- if the corporate bond yields more than 10 %, the investor will be better off with the corporate bond."
References
- Boston Institute of Finance, (2005)., The Boston Institute of Finance Stockbroker Course: Series 7 and 63 Test Prep, John Wiley & Sons, United States of America
- Gitman L. J., Joehnk M. D., Billingsley R., (2013)., Personal Financial Planning, Cengage Learning, United States of America
- Marston R. C., (2014)., Investing for a Lifetime: Managing Wealth for the "New Normal", John Wiley & Sons, United States of America
- Richelson H., Richelson S., (2011)., Bonds: The Unbeaten Path to Secure Investment Growth, John Wiley & Sons, United States of America
- The Securities Institute of America, Inc., (2014)., Wiley Series 65 Exam Review 2015: The Uniform Investment Advisor Law Examination, John Wiley & Sons, United States of America
Footnotes
Author: Aleksandra Walawska
