Bond Equivalent Yield (BEY)
The Bond Equivalent Yield is a term used to describe the yield on a bond.
The bond equivalent yield (BEY) is a financial statistic that allows investors to compute the annual percentage yield on fixed-income assets, even if they are discounted short-term investments that only pay out monthly, quarterly, or semi-annually.
Investors may compare the performance of these assets to that of typical fixed income instruments that last a year or more and provide yearly yields by having BEY numbers at their fingertips. As a result, investors will be able to make better informed decisions when putting up their entire fixed-income portfolios.
Bond Equivalent Yield: What It Is and What It Isn't
To fully comprehend how the bond equivalent yield formula works, you must first understand the fundamentals of bonds and how they vary from stocks.
Stocks (equities) or bonds (bonds) are two options for companies wishing to raise cash (fixed income). Equities, which are allocated to investors in the form of common shares, offer a bigger return potential than bonds, but they also have a higher risk. In particular, if a corporation declares bankruptcy and liquidates its assets, bondholders are first in line to receive any proceeds. Shareholders only see money if there are assets left over.
TAKEAWAYS IMPORTANT
Fixed-income securities come in a variety of shapes and sizes.
Discounted (zero-coupon) bonds have shorter maturities than standard fixed income assets, making yearly yield calculations unfeasible.
The bond equivalent yield (BEY) method can assist investors compare their returns to those of traditional bonds by estimating what a discounted bond would pay yearly.
However, even if a corporation is solvent, its earnings may fall short of expectations. This might lead to a drop in stock prices and losses for investors. However, regardless of whether or not the firm is successful, it is legally compelled to repay its bonds.
Not all bonds are created equal. The majority of bonds pay interest to investors on a yearly or semi-annual basis. However, certain bonds, known as zero-coupon bonds, do not pay any interest. Instead, they're sold at a significant discount to par value, and investors are paid when the bond matures. The bond equivalent yield formula is used by analysts to compare the returns on discounted fixed income products to the returns on regular bonds.
A Look at the Bond Equivalent Yield Formula in More Depth
The bond equivalent yield formula is determined by dividing the difference between the bond's face value and its purchase price by the bond's price. The result is then multiplied by 365 and divided by "d," the number of days left until the bond matures. To put it another way, the first portion of the equation is the conventional return formula for calculating traditional bond yields, while the second component annualizes the first part to get the discounted bond equivalent.
IMPORTANT :Although calculating the bond equivalent yield might be difficult, most current spreadsheets include BEY calculators built-in that can help.
Still perplexed? Consider the following illustration.
Assume an investor pays $900 for a $1,000 zero-coupon bond with the expectation of receiving par value in six months. The investor would receive $100 in this situation. BEY is calculated by subtracting the bond's face value (par) from the actual price paid for the bond:
$900 minus $1,000 equals $100.
The return on investment is calculated by dividing $100 by $900, which is 11%. The second part of the calculation annualized 11 percent by multiplying it by 365 divided by the bond's maturity date, which is half of 365 days. The bond equivalent yield is thus 11 percent divided by two, resulting in a 22 percent yield.
