**What is bond equivalent yield ?**

The bond equivalent yield is the annualized
return earned by an investor holding a discount bond or zero coupon bond. In
other words, is the annualized equivalent yield for those bonds that do not pay
annual interest or pay no interest at all. The main objective of calculating a
Bond equivalent yield of a bond issued at discount is to make it comparable to the
annual yield of other bonds in the money market.

**Why do we calculate bond equivalent yield ?**

The short-term capital market or
money market comprises of several instruments that are issued by companies at
different interest rates and maturity periods. For an investor to take a decision
on the basis of just the interest rate being offered, may not be correct. The
interest rate offered is for a specific period in a year and not annual rate.
In order to take an informed investing decision, the bond equivalent yield is
calculated which gives the annualized return for a given investment in the money
market. This makes comparison of two or more instruments feasible and enables an
informed investment decision.

**How do you calculate Bond
equivalent yield ?**

The bond equivalent yield is the
difference between the Face value and purchase price of a discount bond divided
by the purchase price, which is then annualized by multiplying the result by
365 and dividing by the number of days
to maturity.

The formula for calculating the Bond
equivalent yield is

BEY = [ ( F – P ) / P ] * ( 365 /
N )

Where

F = Face value or par value on
the bond ; P = Purchase price of the bond ;

N = Number of days to maturity ;

** **

**What is the difference between
bank discount yield and bond equivalent yield ?**

Bank discount yield is the annualized
return of a financial instrument that has been issued at a discount. It is
calculated for a period of 360 days. The yield of most Treasury bills issued by
the US Department of Treasury are quoted at the bank discount rate.

This is in contrast to the
annualized return calculated under Bond equivalent yield which uses a 365 day
period.

**What are the drawbacks of Bond
equivalent yield ?**

1.The Bond equivalent yield
formula simply annualizes the yield of the discount bond without effecting the
benefit of compounding.

2.It can be used to calculate bond
equivalent yield of only those instruments that are issued at a discount and do
not pay any interest during its holding period.

**Example :**

Calculate the bond equivalent
yield of a bond with a face value of $ 100,000 that was purchased at a discounted
price of $ 95,000 and has a maturity period of 270 days. ( Round the solution
to two decimal places )

**Solution :**

The
formula for calculation of Bond equivalent yield is

=
[ ( Face value – Purchase Price ) / Purchase Price ] * ( 365 / Number of days
to Maturity)

As
per the Information provided in the question we have

Face
Value = $ 100,000 ; Purchase Price = $ 95,000 ;
No. of days to maturity = 270

Applying
the above values in the formula we have the bond equivalent yield as

=
[ ( 100000 – 95000 ) / 95000 ] * ( 365/270 )

=(
5000 / 95000 ) * 1.351852

=
0.052632 * 1.351852

=
0.071150

=
7.1150 %

=
7.12 %

**Thus
the bond equivalent yield = 7.12 % **