What is a 'Coupon Equivalent Yield (CEY)'

The coupon equivalent yield (CEY) is a method of calculation used to calculate the yield on bonds with maturities of less than one year and which generally sell at a discount. These CEYs do not pay coupons.

BREAKING DOWN 'Coupon Equivalent Yield (CEY)'

Another way to think about coupon equivalent yield (CEY) is as the stated rate of return on bonds without accounting for any compounding. Bonds almost always pay interest semi-annually, the coupon equivalent yield must be compounded just as often to produce the actual annual yield. This calculation is a measure used by many banks in advertising certificates of deposit.

The CEY calculation allows bond investors to compare the return on a 180-day Treasury bill to a one-year coupon paying bond. Investors may use this to evaluate which instrument will give them a higher performance. 

The formula for calculating CEY is:

  • (Market price – Face value) x (365/Days until maturity)

Borrowers typically make interest payments more than once a year, and bond payments are no different. The typical coupon bond pays interest once every six months. Investors have the opportunity to reinvest those payments and increase their return on investment (ROI). The coupon equivalent yield helps the investor calculate precisely what that improved return is, or would have been.

However, it is important to note that the formula assumes the investor can reinvest those interest payments at a rate equal to the bond's coupon rate. This ability is not always possible, depending on prevailing market rates and the investor's financial goals. Typically, an investor in coupon-paying bonds calculates their yield based on the coupon rate and the face value of the bond. However, these two bases do not apply to zero-coupon bonds.
 
It is important to remember that zero coupon bonds do pay interest. Instead, the issuer pays it out upon maturity. Also, zero-coupon bonds do not sell at face value but trade at a discount. At maturity, the investors typically receive more than their investment. Thus, the CEY uses the investor's actual initial investment as a basis for calculating yield, allowing the investor to compare returns from zero-coupon with bonds that pay coupons.

Example of Coupon Equivalent Yield

For example, a 12-percent coupon, $1,000 principal bond pays $60 in interest every six months, resulting in a 12.36 percent yield because the first $60 payment each year can be reinvested to earn an additional $3.60 during the latter half of the year.

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