Tax Equivalent Yield is defined as

• A. the tax-free municipal bond yield divided by (1 - tax rate)
• B. the taxable yield multiplied by (1 - tax rate)
• C. the tax-free municipal yield multiplied by (1 + tax rate)
• D. the municipal yield divided by (1 + tax rate)

Answer: (A)

When evaluating whether a tax-free municipal bond or a taxable bond is the better choice, you convert the tax-free yield into its taxable-equivalent. Tax-equivalent yield is the tax-free yield divided by (1 − your marginal tax rate). This reversal accounts for the tax that would be paid on a taxable investment, so you can compare apples to apples.

For example, if a muni yields 4% and your marginal tax rate is 25%, the TEY is 4% ÷ 0.75 ≈ 5.33%. That means a taxable bond would need about 5.33% before tax to match the after-tax benefit of the 4% tax-free muni for you.

The other expressions don’t fit because they apply the tax rate in the wrong way or direction: multiplying by (1 − tax rate) underestimates the taxable equivalent, multiplying by (1 + tax rate) inflates it incorrectly, and dividing by (1 + tax rate) uses the wrong tax-application direction.