Compute Taxable-Equivalent Yield
Calculate taxable-equivalent yield for a tax-exempt municipal bond.
A tax-exempt municipal bond yields 3.40%. The investor's marginal federal tax rate is 32%. What taxable yield would produce the same after-tax yield, ignoring state taxes and other factors? Taxable-equivalent yield = tax-exempt yield / (1 - marginal tax rate) The common trap is to compare the muni's 3.40% directly with a taxable bond's yield without adjusting for tax. Step 1 Convert the tax rate: 32% becomes 0.32. The formula needs the marginal tax rate for the investor whose after-tax return you are comparing. Step 2 Calculate the after-tax retention rate: 1 - 0.32 = 0.68. A taxable bond investor…
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