6.19.2005

Q&A: Which bond is more attractive...

...given these two bonds (all else equal?)
  • A Eurobond that pays coupon annually, with an annual-pay YTM of 8%.
  • A US corporate bond that pays coupon semiannually, with a bond equivalent YTM of 7.8%.

A: convert the Eurobond's annual-pay yield to a BEY (bond equivalent yield): 2 * [ (1 + 0.08)^0.5 - 1] = 7.85% > 7.8%.

Bonus Points

  • Bond yields conventionally computed based on semiannual periods, as US bonds typically make two coupon payments per year. It is an internal rate of return with semiannual compounding.
  • The yield of a semiannual-pay cannot be compared directly against an annual-pay bonds without conversion. BEY is the convention for restating a non-annual yield into an annual one - allows securities whose payments are not annual to be compared with the ones with annual yields. For example, the yield of the above corp bond is 3.9%, its BEY is 7.8%. BEY
  • BEY ignores the effect of compounding semiannual YTM. To take compounding effect into account,
    • Convert the equivalent annual yield of an annual-pay bond to a BEY: 2 * [ (1 + annualYTM)^0.5 - 1]
    • Convert a semiannual-pay bond's BEY to an annual-pay bond: [1 + semiAnnual BEY/2] ^ 2 - 1

Category: Debt > Valuation

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