Money Market Equivalent Yield Vs. Bond Equivalent Yield

by Eric Bank Google

    Yields provide investors a way to comparison-shop among different interest-bearing investments. Yields put investments on a common footing by accounting for price and timing differences so that you have a good idea of what your return will be if you hold the investment until maturity. Money market equivalent yield -- also known as CD equivalent yield -- is used for short-term discount investments such as Treasury bills. Bond equivalent yield is similar to money market equivalent yield, except for the assumed number of days in a year.

    The function of a yield is to account for investment return on an annualized basis. Holding period yield, or HPY, is the one of the most basic yield calculations and is the basis of money market yield. HPY gives you the yield for holding an investment until it matures. This yield is not annualized. To calculate HPY, subtract 1 from the ratio of ending value to beginning value. For example, suppose you purchase a $5,000 T-Bill for $4,970 that matures in 100 days. HPY is ($5,000 divided by $4,970) minus 1, or 0.6036 percent.

    The money market equivalent yield puts the HPY on an annualized footing. The calculation is to multiply the HPY by the ratio of days in a year to days until maturity. In the example, this equals 0.6036 percent times (360 days in year divided by 100 days until maturity), or 2.173 percent. The money market equivalent yield only makes sense for investments that don’t pay out interest until maturity -- such as a T-Bill or zero-coupon bond -- because it doesn't account for interim interest payments or the effect of compounding. A T-Bill is a pure discount instrument in which the interest is the difference between the purchase price and face value at maturity.

    An alternative way to state the annualized yield on a discount instrument is the bond equivalent yield, or BEY, which uses a 365-day year and is therefore more realistic than the money market equivalent yield. The BEY of a bond is its HPY times the ratio of 365 days in the year to the number of days until the bond matures. From the previous example, the 100-day T-Bill’s BEY is 0.6036 percent times (365 days in year divided by 100 days until maturity), or 2.2032 percent. Like money market equivalent yield, BEY is suited for zero-coupon investments that do not compound.

    Lenders and credit card providers must disclose the annual percentage rate, or APR, they will charge on borrowed funds. The APR closely resembles the BEY, in that it annualizes a yield without accounting for compounding. For example, if a credit card company charges 1 percent per month on your outstanding balance, the APR is 12 times 1 percent, or 12 percent. A more realistic number is the annual percentage yield, or APY, which is calculated as ((1 plus the periodic rate) raised to the number of periods in a year) minus 1. The APY for the same credit card is ((1 + .01) ^ 12) - 1, or 12.6825 percent. The APY accounts for compounding, and you can apply it to investments such as CDs that compound over their holding periods.

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    About the Author

    Based in Chicago, Eric Bank has been writing business-related articles since 1985, and science articles since 2010. His articles have appeared in "PC Magazine" and on numerous websites. He holds a B.S. in biology and an M.B.A. from New York University. He also holds an M.S. in finance from DePaul University.

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