Bond Equivalent Yield FormulaDefined along with Formula & How to Calculate

Written By:
Lisa Borga

The bond equivalent yield (BEY) formula provides a method for calculating the annual yield of fixed-income securities, including discount or zero-coupon bonds with returns on a less than annual basis.

BEY is an incredibly useful tool for investors to compare the potential performance of traditional bonds with an annual return against those with more frequent payments.

This allows investors to make more educated decisions when building their investment portfolios.

Bond Equivalent Yield Formula

Before considering the bond equivalent yield more closely, here is the formula for calculating it:

Bond Equivalent Yield = ((F-P)/P) * (365/D)

Where:

F = Par Value

P = Purchase Price of the Bond

Duration of Bond/Days to Maturity

BEY is calculated by first taking the par or face value of the bond and subtracting the purchase price.

This is then divided by the purchase price for the bond, and you have the first number you will need.

Next, divide 365 by the number of days until the bond reaches maturity and multiply this number by the one you reached in the previous step.

Now you have your bond equivalent yield and can multiply this number by 100 to convert it to a percentage.

You might also notice that the first part of this equation is simply the standard formula for the calculation of finding bond yield.

However, in the second part of the formula, this is converted to an annual format allowing it to be easily compared with traditional bonds.

Bond Equivalent Yields Explained

The equivalent bond yield is a formula that allows investors to compare the yield of any short-term securities they have purchased at a discount to a bond that has an annual yield.

This can be used for bonds that pay on a semi-annual, monthly, or quarterly basis.

Having this metric available can help investors to make better decisions as to what investments they should choose for their portfolio.

In order to adequately understand how to use the BEY formula, you’ll need to understand some basic information about bonds and how they are different from stocks.

When a company wants to raise some capital, it can choose to issue stock, which is equity in the company, or bonds, which are a type of fixed income.

When an investor has equity in a company, they have the potential for a greater return on the company than they would receive from bonds.

However, they are also taking on increased risk.

The risk is higher for stock because should the company declare bankruptcy and its assets are liquidated, bondholders will be paid first.

Stockholders are the last to receive money and have a good chance of receiving little or nothing.

Even if the company does not go bankrupt, it may suffer a loss of revenue, causing stock prices to decline, resulting in a loss for stockholders.

However, no matter how a company performs, it is still required to pay bondholders.

Though bonds possess a far greater level of security when compared with equities, there are several types of bonds with different properties.

The majority of bonds provide investors with semi-annual or annual interest payments.

However, zero-coupon bonds do not offer interest at all. Investors will instead purchase these bonds at a significant discount beneath the par value and receive returns when the bond has matured.

In order to compare the returns on these zero-coupon bonds with traditional bonds that provide an annual interest payment, an investor must use the BEY formula, which annualizes the return.

BEY Example

For an example of the BEY formula in use, suppose that an investor purchases a $2,000 zero-coupon bond, which they pay $1,700 for.

The investor is expecting to be paid the par value for the bond in six months.

This means the investor will make a $300 profit.

$2,000 – $1,700 = $300

To calculate the return on investment, you need to divide the $300 profit by the $1,700 that was paid for the bond, which will show a return on investment of 17.6%.

Then, you annualize the 17.6%.

To do this, multiply 17.6% by 365 divided by the number of days remaining until the bond matures.

For six months, this would be 2.

Therefore, the BEY would be 17.6% x 2, which would be 35.2%.

Key Takeaways

• The returns on fixed-income securities can come with considerably different frequencies, and the BEY formula helps to adjust for these different rates of payout.
• Discounted bonds possess a period of return shorter than one year, which means it is not possible to calculate an exact annual yield.
• With the BEY formula, investors can calculate an approximate annual return for discounted bonds allowing them to compare the payout against other fixed-income investment options that possess an annual return.