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- How do I Compute Bond Equivalent Yield & the Effective Annual Rate?
The annual percentage yield, or APY, takes into account the compounding effects of interest calculated from the annual percentage rate, or APR, which is the simple interest rate. APY is also called the effective interest rate, because it is the rate you effectively receive over the span of a year. Some bonds make regularly scheduled coupon payments based on the APR. For these bonds, interest earned is not reinvested, so the APY equals the APR. However, bonds that retain interest until a maturity date compound that interest. If the compounding period is not an annual one, the APY and APR differ.
Divide the bond's APR or coupon rate by the number of compounding periods in a year. As an example, a U.S. Savings Bond compounds semiannually. If it offers a 6 percent APR, divide 6 by 2 to calculate a periodic interest rate of 3 percent.Step 2
Divide this figure by 100 to convert it to decimal format. Continuing with the example, divide 3 percent by 100 to get 0.03.Step 3
Add one to the result. In the example, add 1 to 0.03 to get 1.03.Step 4
Raise the result to the power of the number of compounding periods. Continuing with the example, raise 1.03 to the 2nd power to get 1.0609.Step 5
Subtract 1 from the result to calculate the APY in decimal format. In the example, 1.0609 minus 1 leaves you with an APY of 0.0609.Step 6
Multiply by 100 to convert the decimal APY to percentage format. In the example, 0.0609 times 100 gives you an APY of 6.09 percent.
- The entire formula for calculating bond APR is:
- APY = (1+APR/n)^n - 1
- Where "n" is the number of compounding periods in a year, and APY and APR are expressed as decimal figures.
- savings bonds image by Stephen VanHorn from Fotolia.com