What Is the Bond Equivalent Yield?

A bond equivalent yield (BEY) shows the annual return on a bond. Discounted bonds don’t pay regular interest, while traditional bonds do. The BEY converts the discount bond’s return into an annual rate, so investors can compare it directly with the yearly yields of traditional bonds. As an investor, you can calculate the BEY by taking the difference between a bond’s face value and its purchase price, dividing that by the purchase price, and then adjusting it to a yearly rate based on how many days are left until the bond matures.

How Bond Equivalent Yield Simplifies Investment Decisions

To truly understand how the bond equivalent yield formula works, it's important to know the basics of bonds in general and to grasp how bonds differ from stocks.

Companies can raise capital by issuing stocks or bonds. Stocks may offer higher returns than bonds but come with more risk. In bankruptcy, bondholders get paid before shareholders, who only receive money if assets remain.

But even if a company remains solvent, its earnings may nonetheless fall short of expectations. This could depress share prices and cause losses to stockholders. But that same company is legally obligated to pay back its debt to bondholders, regardless of how profitable it may or may not be.

Not all bonds are the same. Most pay interest annually or semi-annually, but zero-coupon bonds don’t pay interest. Instead, they sell at a discount and pay at maturity. To compare the return on discounted fixed income securities with the returns on traditional bonds, analysts rely on the bond equivalent yield formula.

Calculating the Bond Equivalent Yield: A Step-by-Step Guide

1. Identify values: Start by identifying the bond's face value and the purchase price. For example, if a bond's face value is $1,000 and it costs $900, note these figures.
   
2. Calculate the return: Subtract the bond’s purchase price from its face value to determine the return. ($1,000 - $900 = $100)
3. Find the return on investment: Divide the return ($100) by the bond's purchase price ($900) to get the return on investment (11%).
   
4. Annualize the return: Multiply the return on investment (11%) by 365, then divide by the number of days until maturity (in this example, 182.5 days), and then simplify the fraction. This will give you the annual Bond Equivalent Yield of 22%.