What is Coupon Equivalent Yield (CEY)?
- Coupon equivalent yield (CEY) is used to calculate the annualized yield, without accounting for compounding, on bonds with maturities under one year.
- CEY allows investors to compare the return on, say a 60-day Treasury bill to a one-year coupon-paying bond, or another similar security that pays an annual yield.
- CEY is a nominal yield and should not be confused with an effective annual yield, which factors in compounding.
Understanding Coupon Equivalent Yield (CEY)
The coupon equivalent yield (CEY), also known as bond equivalent yield, is a simple rate of interest that takes into account the discounted purchase price of the bond. It allows investors to compare the return on, say a 60-day Treasury bill to a one-year coupon-paying bond, or another similar security that pays an annual yield. Investors can use the coupon equivalent yield to calculate which investment results in better annualized performance.
The formula for coupon equivalent yield is:
CEY = [(Par Value - Current Price) ÷ Current price ] * (365 ÷ days to maturity) * 100
For example, say a bond has a par value of $10,000, and its current price is $9.970. It has 60 days until maturity. Using the calculation, its coupon equivalent yield:
CEY = [($10,000 - $9,970) ÷ $9,970] * (365 ÷ 60) * 100 = 1.83%.
The coupon equivalent yield helps investors calculate what the return on a short-term Treasury bill would have been, had they been able to collect the same rate of interest for a full year.
Of note, some investors also calculate a coupon equivalent yield for commercial paper and other short-term corporate bonds. This requires a slightly different calculation, as follows:
CEY = (Interest payment ÷ Current price) * (365÷ days to maturity)
Using the prior example of a bond with a $10,000 par value selling currently for $9,970 with an annual interest of 2% paid semi-annually. The bond matures in 60 days during which time there is one interest payment of $100 expected to be made. The coupon equivalent yield would be:
CEY = ($100 ÷ $9,970) * (365 ÷ 60) = 6.10%
Coupon Equivalent Yield vs. Effective Annual Yield
The coupon equivalent should not be confused with an effective annual yield, which takes into account compounding. The coupon equivalent yield is a nominal yield, so it does not use any compounding. It, therefore, gives a more conservative estimation of yield compared with an effective annual yield. The latter tends to be used in advertisements for short-term investment returns, as the compounding tends to make the return look a bit better.