Question

One-hundred-eighty-day commercial paper can be bought at a 3.75 percent discount. What are the bond equivalent yield and the effective annual rate on the commercial paper? Why do these rates differ?

Answer 1

Commercial paper price (assumes 100 par) = 100*(1 – (0.04*1800/360)) = 98.13

Effective annual rate_CP= (100 / 98.13)^365/180– 1 = 3.91%

Bond equivalent yield = [(100 – 98.13) / 98.13] * 365/180 = 3.875%

360 days in a year is assumed to Calculate the discount quote. The bond equivalent yield is an annual rate calculated as (Par – Price) / Price, which is the normal way to express a percentage return ($ return per $ invested), assuming that there are 365 days in the year. The effective annual return or EAR is the same as the bond equivalent yield, except that the EAR annualise the rate of return assuming the proceeds from each 180 day period are reinvested during the next 180 day period.