"Coupon Equivalent Yield (CEY), also known as Bond Equivalent Yield (BEY), is a financial metric used to compare the yield of a discount security, such as a Treasury bill, with the yield of a coupon-bearing security, such as a bond."
Introduction
Coupon Equivalent Yield (CEY), also known as Bond Equivalent Yield (BEY), is a financial metric used to compare the yield of a discount security, such as a Treasury bill, with the yield of a coupon-bearing security, such as a bond. It allows investors to determine the true yield of a discount security on an annualized basis, making it easier to compare different types of fixed-income investments.
In this article, we explore the concept of Coupon Equivalent Yield, its calculation, and its significance in fixed-income investing.
Understanding Coupon Equivalent Yield (CEY):
When comparing the yields of different fixed-income securities, it is essential to consider the time value of money and the compounding effect of interest over time. Coupon-bearing securities, such as bonds, make periodic interest payments to the bondholder, while discount securities, like Treasury bills, are issued at a discount to their face value and do not make interest payments during their term.
CEY is a formula used to annualize the yield of a discount security to make it comparable to the yield of a coupon-bearing security. By expressing the yield on an annual basis, investors can effectively compare the relative returns of different fixed-income instruments with varying maturities and interest payment structures.
Calculation of Coupon Equivalent Yield (CEY):
The formula to calculate Coupon Equivalent Yield is as follows:
CEY = (Discount / Price) * (365 / Days to Maturity)
Where:
- Discount is the difference between the face value and the purchase price of the discount security.
- Price is the purchase price of the discount security.
- Days to Maturity is the number of days remaining until the discount security matures.
Significance in Fixed-Income Investing:
Coupon Equivalent Yield helps investors assess the relative attractiveness of discount securities compared to coupon-bearing securities. By annualizing the yield of discount securities, CEY provides a useful tool for comparing investments with different timeframes and interest payment structures.
For example, suppose an investor is considering investing in a 90-day Treasury bill with a face value of $10,000, which is currently trading at a discount price of $9,800. Using the CEY formula:
Discount = $10,000 - $9,800 = $200 Days to Maturity = 90 days
CEY = ($200 / $9,800) * (365 / 90) ≈ 0.0816 or 8.16%
The calculated CEY of approximately 8.16% provides an annualized yield for the Treasury bill, allowing the investor to compare this short-term discount security's return to other fixed-income investments, such as bonds with different maturities and coupon rates.
Conclusion:
Coupon Equivalent Yield (CEY) is a valuable tool in fixed-income investing that helps investors compare the yield of discount securities with coupon-bearing securities on an annualized basis. By considering the time value of money, CEY enables investors to make informed decisions when choosing between different fixed-income instruments with varying yields, maturities, and payment structures.
Investors should use CEY as part of their investment analysis to assess the relative attractiveness of various fixed-income opportunities and align their investment choices with their financial goals and risk tolerance.
Posted On:
Thursday, 18 April, 2024