Fixed coupon equivalent

Although no coupons are paid periodically, the investor will receive the return upon sell assuming that the rates remain constant or upon maturity.

How to compare the yields of different bonds

The zero coupon bond effective yield formula shown up top takes into consideration the effect of compounding. For example, suppose that a discount bond has five years until maturity. If the number of years is used for n , then the annual yield is calculated.

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Considering that multiple years are involved, calculating a rate that takes time value of money and compounding into consideration is needed. In contrast, the formula for the bond equivalent yield does not take compounding into consideration. For this reason, the formula for bond equivalent yield is primarily used to compare discount bonds of short maturity, specifically less than one year. The formula for calculating the effective yield on a discount bond, or zero coupon bond, can be found by rearranging the present value of a zero coupon bond formula:.

By subtracting 1 from the both sides, the result would be the formula shown at the top of the page. This site was designed for educational purposes. But investors have the opportunity to reinvest those payments, and this increases the return on the investment. However, it is important to note that the formula assumes the investor can reinvest those interest payments at a rate equal to the bond 's coupon rate.

Computing Effective Annual Rate

This is not always possible, depending on prevailing market rates and the investor's financial goals. Show 5 More. Our in-depth tools give millions of people across the globe highly detailed and thoroughly explained answers to their most important financial questions.

3.6 - Pricing a Coupon Bond as a Sum of Zero-Coupon Bonds

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Coupon Equivalent Yield (CEY)

What it is: The formula for CEY is: How it works Example: Using these circumstances and the formula above, we can determine that the bond 's effective annual interest rate is: Why it Matters: Popular Now. What is a Small-Cap Stock? Profiting from Options.