The After-Tax Yield to Maturity of a Premium Bond: Bias from a Simple Approximation

Andrea Heuson, Ricardo J. Rodriguez

Research output: Contribution to journalReview article

Abstract

When finding the after-tax yield to maturity of a bond, it is customary to use the approximate relationship: After-tax yield = (1 - tax rate) × (before-tax yield). This paper provides a theoretical justification for this simplified formula by showing that, for premium bonds, it can be obtained from the complex implicit function defining the exact after-tax yield by using a first-order Taylor series approximation. Such simple approximations normally result in potentially large errors, and this is indeed what our simulation results show. Nevertheless, the approximation formula's error possesses the desirable properties that it is consistent in sign and bounded. Hence, the approximate formula, although easy to apply, should be used with caution.

Original languageEnglish (US)
Pages (from-to)183-191
Number of pages9
JournalJournal of Accounting, Auditing & Finance
Volume8
Issue number2
DOIs
StatePublished - Jan 1 1993

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics, Econometrics and Finance (miscellaneous)

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