"Tax equivalent yield" is a method of measuring the return on tax exempt investments in comparison to taxable investments. It is often used to compare the return on taxable bonds versus the tax-free yield of a municipal bond. The following formula illustrates how the yield of a tax-free bond can be compared to a taxable bond to determine which bond has a higher yield:

Tax Equivalent Yield = Tax free municipal bond yield / 1-tax rate

For example, if a tax-free bond has a yield of 15% and the tax rate is 15%, a taxable bond would need a pretax yield of 17.6% (15% ÷ 85%) in order to be considered an equivalent investment. Bonds with the same risk but with a pretax yield of less than 17.6% would be considered inferior investments compared to a 15% municipal bond.