Tax equivalent yield is the interest rate that must be offered by a taxable bond of similar quality in order to be equal to the rate that is offered by a municipal bond.
Applying "Tax Equivalent Yield" to Securities Exams:
When comparing a municipal bond with a corporate bond investors have to consider the impact of taxes on the interest income received from the corporate bond. While the interest rates on municipal bonds are lower than those of similar quality corporate bonds, the taxable nature of the corporate bond may result in a lower after tax yield for the investor. To determine the tax equivalent yield use the following formula TEY = Muni Rate / (100% – investors tax rate)