Bond equivalent yield is a way to compare the yield of a debt instrument with an interest-bearing coupon value. It is calculated by dividing the purchase price per thousand shares by the purchase price and multiplying it by a figure representing the time period. The purpose is to determine if the investment is worthwhile.
The bond equivalent yield is essentially a restatement of the yield of a debt instrument, taking into account various factors that intervene with respect to the interest on the asset. Equivalent bond yields are produced as a means of creating a means of comparison with an interest-bearing coupon value.
The basic detail that is required to start the process of determining the equivalent bond yield is quite simple. The purchase price per thousand shares is divided into the purchase price. That figure is multiplied by a figure that represents the number of days until expiration divided by the number of days in the period considered. The time period can be monthly, quarterly, semi-annually, or annually.
It is important to note that in order for the equivalent bond yield to be determined by this formula it must be compared to a security that also has the same time period. As an example, if the equivalent bond yield is calculated using a one-year time period, the collateral used for comparison must also be annual in nature. However, it should be noted that the formula for equivalent bond yield makes it possible to compare fixed income securities whose payments are not annual with a security that does have an annual yield. This would require the additional step of aggregating all payments received within the one year period to create a comparison that is uniform in nature.
The purpose of using a bond equivalent yield for a given security coupon is to draw conclusions about the level of yield of the debt instrument. Essentially, doing the comparison will help an investor know whether the amount of resources that have been invested in the debt instrument is likely to provide enough interest income to make the effort worthwhile. If the comparison indicates that the debt instrument does not provide a return that is in line with what a different interest-bearing investment would produce, the investor may elect to sell the interest on the debt instrument. At that point, the investor may choose to take the proceeds from the sale and reinvest the funds in a more profitable venture.
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