1. What is Tax Equivalent Yield?

Tax Equivalent Yield (TEY) is a calculation that allows investors to compare the yield of a tax-free investment (such as municipal bonds) to that of a taxable investment. It shows what yield you would need to earn on a taxable investment to match the after-tax return of a tax-free investment.

2. How Does the Calculator Work?

The calculator uses the Tax Equivalent Yield formula:

Where:

• \( r_{tf} \) — Tax-free yield (expressed as a decimal)
• \( t \) — Investor's marginal tax rate (expressed as a decimal)

Explanation: The formula adjusts the tax-free yield to show what equivalent taxable yield would be required to produce the same after-tax return.

3. Importance of Tax Equivalent Yield

Details: TEY is crucial for investment decision-making, particularly when comparing municipal bonds (which are often tax-exempt) with taxable bonds or other investments. It helps investors make apples-to-apples comparisons between different types of investments.

4. Using the Calculator

Tips: Enter the tax-free yield as a decimal (e.g., 0.05 for 5%) and your marginal tax rate as a decimal (e.g., 0.25 for 25%). Both values must be valid numbers within their respective ranges.

5. Frequently Asked Questions (FAQ)

Q1: Why is Tax Equivalent Yield important for investors?
A: TEY helps investors compare tax-free and taxable investments on an equal basis, ensuring they make informed decisions about which investment provides better after-tax returns.

Q2: What's the difference between tax-free yield and taxable equivalent yield?
A: Tax-free yield is the actual yield of the investment, while taxable equivalent yield shows what yield a taxable investment would need to produce the same after-tax return.

Q3: How do I convert percentage to decimal for the calculator?
A: Divide the percentage by 100. For example, 5% becomes 0.05, and 25% becomes 0.25.

Q4: Does this calculation work for all tax brackets?
A: Yes, but you should use your marginal tax rate (the rate at which your last dollar of income is taxed) for the most accurate comparison.

Q5: Are there any limitations to this calculation?
A: The calculation assumes that all other factors (risk, liquidity, etc.) are equal between the investments being compared. It also doesn't account for state and local taxes, which may affect the actual comparison.