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Yield Equivalence
Yield Equivalence is a ratio that shows how high interest rate on a taxable investment would have to be in order to match returns of tax-exempt investments like municipal bonds.
Yield equivalence is calculated by the following equation:
Tax exempt yield / (1- tax rate)
By dividing yield on a tax-exempt investment by 1 – tax rate, you would get a necessary return on taxable investment, expressed in percentage, to provide the same return like the municipal bond.
If tax-exempt municipal bond provides 5% yield, and you want to calculate what the interest rate on a taxable instrument would have to be to provide the same return, with 18% rate of taxation, taxable investment instrument would have to provide 6.1% return:
5 % / (1-0.18) = 6.097%
Yield equivalence is also called "equivalent taxable yield."
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