What Does Bond Equivalent Yield Mean?
The bond equivalent yield (BEY) allows fixed-income securities whose payments are not annual to be compared with securities with annual yields. The BEY is a calculation for restating semi-annual, quarterly or monthly discount bond or note yields into an annual yield, and is the yield quoted in newspapers. Alternatively, if the semi-annual or quarterly yield to maturity of a bond is known, the annual percentage rate (APR) calculation may be used.
Bond Equivalent Yield (BEY)
Understanding Bond Equivalent Yield
Companies can raise capital in two main ways: debt or equity. Equity is distributed to investors in the form of common shares; it comes second to debt in case of bankruptcy or default, and it may not provide the investor with a return if the company fails. By contrast, debt is considered cheaper for the company to issue and is safer than equity for investors. Still, the debt must be paid back by the company, regardless of earnings growth. In this way, it provides a more reliable stream of income for the bond investor.
Not all bonds are made equal, however. Most bonds pay investors annual or semi-annual interest payments. Some bonds, referred to as zero-coupon bonds, do not pay interest at all, but are instead issued at a deep discount to par. The investor makes a return when the bond matures. To compare the return on discounted securities with other investments in relative terms, analysts use the bond equivalent yield formula.
The Bond Equivalent Yield Formula
The bond equivalent yield formula is calculated by dividing the difference between the face value of the bond and the purchase price of the bond by the price of the bond. Take the answer and multiply by 365 divided by d, where "d" equals the number of days until maturity. The first part of the equation is the standard return formula and shows the return on investment. The second portion of the formula annualizes the first part of the formula.
As an example, if an investor buys a $1,000 zero-coupon bond for $900 and expects to be paid par value in six months, he earns $100. The first part of the calculation is par or face value minus the price of the bond. The answer is $1,000 minus $900, or $100. Next, divide $100 by $900 to obtain 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 of 365. The bond equivalent yield is therefore 11% multiplied by two, or 22%.