Bond Equivalent Yield (BEY)
What Is the Bond Equivalent Yield?
In financial terms, the bond equivalent yield (BEY) may be a metric that lets investors calculate the annual percentage yield for fixed-come securities, albeit they're discounted short-term plays that only disburse on a monthly, quarterly, or semi-annual basis.
However, by having BEY figures at their fingertips, investors can
compare the performance of those investments with those of traditional fixed
income securities that last a year or more and produce annual yields. This
empowers investors to form more informed choices when constructing their
overall fixed-income portfolios.
Understanding Bond Equivalent Yield
To truly understand how the bond equivalent yield formula works,
it is vital to understand the fundamentals of bonds generally and to understand
how bonds differ from stocks.
Companies looking to boost capital may either issue stocks
(equities) or bonds (fixed income). Equities, which are distributed to
investors within the sort of common stock, have the potential to earn higher
returns than bonds, but they also carry greater risk. Specifically, if a
corporation files for bankruptcy and subsequently liquidates its assets, its
bondholders are first in line to gather any cash. as long as there are assets
left over to shareholders see any money.
But albeit a corporation remains solvent, its earnings may
nonetheless come short of expectations. this might depress share prices and
cause losses to stockholders. But that very same company is legally obligated
to pay back its debt to bondholders, no matter how profitable it's going to or
might not be.
Not all bonds are equivalent. Most bonds pay investors annual or
semi-annual interest payments. But some bonds mentioned as zero-coupon bonds,
don't pay interest in the least. Instead, they're issued at a deep discount to
par, and investors collect returns when the bond matures. to match the return
on discounted fixed income securities with the returns on traditional bonds,
analysts believe the bond equivalent yield formula.
KEY TAKEAWAYS
- Fixed income securities are available in different forms.
- Discounted (zero-coupon) bonds have shorter durations than
traditional fixed income securities, which makes it impossible to calculate
their annual yields.
- The bond equivalent yield (BEY) formula can help approximate what a reduced bond would pay annually, letting investors compare their returns with those of traditional bonds.
A Closer check out the Bond Equivalent Yield Formula
The bond equivalent yield formula is calculated by dividing the difference between the face value of the bond and therefore the price of the bond, by the worth of the bond. That answer is then multiplied by 365 divided by "d," which represents the number of days left until the bond's maturity. In other words, the primary part of the equation is that the standard return formula wont to calculate traditional bond yields, while the second part of the formula annualizes the primary part, to work out the equivalent figure for discounted bonds.
Still, confused? Consider the subsequent example.
Assume an investor buys a $1,000 zero-coupon bond for $900 and
expects to be paid face value in six months. during this case, the investor
would pocket $100. to work out BEY, we take the bond's face value (par) and
subtract the particular price purchased the bond:
$1,000 - $900 = $100
We then divide $100 by $900 to get the return on investment, which
is 11%. The second portion of the formula annualizes 11% by multiplying it by
365 divided by the number of days until the bond matures, which is half 365.
The bond equivalent yield is thus 11% multiplied by two, which comes bent 22%.
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