Tax Equivalent Yield

The taxable equivalent yield (TEY) equation is used to compare the yield between a tax-exempt investment (e.g. Municipal bonds) and an investment that is taxed.

EXAMPLE

If a tax-free bond has a yield of 36% and the tax rate is 12%, a taxable bond would need a pretax yield of 40.9% (36%/88%) in order to be considered an equivalent investment. Therefore, all bonds with the same risk but with a pretax yield of less than 40.9% should be considered inferior investments compared to the 36% municipal bond.