A tax-exempt bond typically pays a lower interest rate than its taxable equivalent, but may have a higher after-tax yield, depending on your tax bracket and state tax laws. Example: Bond A is a tax-exempt bond paying 4%; Bond B is a taxable bond paying 6%.
Which bond would give you a higher after-tax return?
Taxable bonds, such as corporate bonds, may offer higher returns than tax-exempt bonds, such as municipal bonds. Calculating the after-tax basis will allow an investor to make a better decision that will maximize their portfolio’s return.
What is the taxable equivalent yield on a municipal bond?
The tax-equivalent yield is the return that a taxable bond would need to equal the yield on a comparable tax-exempt municipal bond. The calculation is a tool that investors can use to compare the returns between a tax-free investment and a taxable alternative.
What would be your equivalent taxable yield if you are in a 35% tax bracket and can earn 6% on a municipal bond?
Taxable Equivalent Yields
This tells you that in your tax bracket (35%), a municipal bond yield of 3.33% is equivalent to a taxable bond that has a yield of 5.08%.
What is tax-equivalent yield?
Updated June 05, 2021. The tax-equivalent yield (TEY) of a bond is the return that a taxable bond needs in order to be equal to the return on a tax-exempt municipal bond.
What is the average return on bonds?
Over the long term, stocks do better. Since 1926, large stocks have returned an average of 10 % per year; long-term government bonds have returned between 5% and 6%, according to investment researcher Morningstar.
What is the difference between bond yield and interest rate?
Yield is the annual net profit that an investor earns on an investment. The interest rate is the percentage charged by a lender for a loan. The yield on new investments in debt of any kind reflects interest rates at the time they are issued.
How do you calculate bond yield?
Yield is a figure that shows the return you get on a bond. The simplest version of yield is calculated by the following formula: yield = coupon amount/price. When the price changes, so does the yield.
How do you calculate after-tax preferred yield?
The effective after-tax yield can be found by multiplying the percentage of yield after taxes by the pre-tax rate of return. If the investment in this example returns 8 percent, that number would be multiplied by 0.70 to get an after-tax yield of 5.6 percent.
How do you calculate after tax return on a bond?
To calculate the real rate of return after tax, divide 1 plus the after-tax return by 1 plus the inflation rate. Dividing by inflation reflects the fact a dollar in hand today is worth more than a dollar in hand tomorrow.
At what tax rate would an investor be indifferent?
The indifferent marginal tax bracket T would be 40%. Investors in a > 40% marginal tax bracket would receive a higher after tax yield investing in the tax-free municipal bonds, while those investors in a <40% marginal tax bracket would obtain a higher after tax yield investing in these taxable bonds.
Why would a company want to call a bond?
A callable bond allows the issuing company to pay off their debt early. A business may choose to call their bond if market interest rates move lower, which will allow them to re-borrow at a more beneficial rate.