What is Bond Equivalent Yield?

What is Bond Equivalent Yield?

In financial terms, the bond equivalent yield (BEY) is a metric that lets investors calculate the annual percentage yield for fixed-income securities, even if they are discounted short-term plays that only pay out on a monthly, quarterly, or semi-annual basis. It is a rate that helps an investor determine the annual yield of a bond (or any other fixed-income security), that does not provide an annual payout. In other words, bond equivalent yield helps an investor find an “equivalent yield” between two or more bonds.

By having BEY figures at their fingertips, investors can compare the performance of these investments with those of traditional fixed income securities that last a year or more and produce annual yields. This empowers investors to make more informed choices when constructing their overall fixed-income portfolios. The formula of Bond Equivalent Yield is:

BEY=(( Par Value - Purchase Price ) ÷ ( Purchase Price )) × (365÷d)

Where

d=Days to maturity on which the par value will be paid to the investor

Par value= price that will be paid on maturity of the bond.

Purchase price= price the investor paid for acquiring the bond (lesser than the par value in the case of a deep discount or zero-coupon bond)

Illustration:

From the above BEY calculations, it can be concluded that Bond A is a better investment option since its yield is higher as compared to Bond B.

How is Bond Equivalent Yield useful?
Bonds and other related fixed-income securities offer periodic interest payments to investors referred to as coupon payments, provide a steady stream of income for bond investors. But some bonds, referred to as zero-coupon bonds, do not pay interest at all. Instead, they are issued at a deep discount to par, and investors collect returns when the bond matures.

• To compare the return on discounted fixed income securities with the returns on traditional bonds, BEY formula makes a logical comparison.
• BEY is especially useful when an investor has to decide between two or more fixed investment products with different maturities.

Since returns are one of the primary criteria for making any investment choice, it becomes absolutely essential to compare the rates of return of different investment instruments, despite the difference in payment frequencies. However, the downside of using the BEY method is that it does not recognize the effect of compounding for shorter duration bonds and therefore might not provide a true and fair picture in certain situations.

Key Takeaways

• Bond equivalent yield (BEY) allows investors to calculate the annual percentage yield for fixed-income securities including those which pay out in the short term
• BEY helps an investor find an “equivalent yield” between two or more bonds
• Between two securities, the one with the higher BEY is more favourable
• BEY is very useful to compare two or more fixed investment products with different maturities
• However, it does not recognize the effect of compounding for shorter duration bonds and therefore might not provide a true and fair picture in certain situations

This material is part of an Investor Education and Awareness Initiative of Canara Robeco Mutual Fund