Hi,
i am very confused when to use:
1. the calculation for PV or FV and
2. PV or FV in the denominator for the calculation of the bond equivalent yield.
From the question below, it seems that the use of PV and its use as a denominator applies when a Discount Rate is given and FV should be used when an Add-On Rate is given. If my understanding is correct, why so?
Appreciate your help on this please.
Thanks and have a good weekend!
Suppose that a money market investor observes quoted rates on the following four 180-day money market instruments:
Money Market Instrument Quotation Basis Assumed No. of Days in the Year Quoted Rate
A Discount Rate 360 4.33%
B Discount Rate 365 4.36%
C Add-On Rate 360 4.35%
D Add-On Rate 365 4.45%
Calculate the bond equivalent yield for each instrument. Which instrument offers the investor the highest rate of return if the credit risk is the same?
Solution:
A PV=100 x [1 - 180/360 x 0.0433] = 97.835
AOR= [365/180] x [(100-97.835) / 97.835] = 0.04487
The bond equivalent yield for Bond A is 4.487%
C FV=100 + [100 x (180/360) x 0.0435] = 102.175
AOR= [365/180] x [(102.175-100) / 100] = 0.04410
The bond equivalent yield for Bond A is 4.410%
i am very confused when to use:
1. the calculation for PV or FV and
2. PV or FV in the denominator for the calculation of the bond equivalent yield.
From the question below, it seems that the use of PV and its use as a denominator applies when a Discount Rate is given and FV should be used when an Add-On Rate is given. If my understanding is correct, why so?
Appreciate your help on this please.
Thanks and have a good weekend!
Suppose that a money market investor observes quoted rates on the following four 180-day money market instruments:
Money Market Instrument Quotation Basis Assumed No. of Days in the Year Quoted Rate
A Discount Rate 360 4.33%
B Discount Rate 365 4.36%
C Add-On Rate 360 4.35%
D Add-On Rate 365 4.45%
Calculate the bond equivalent yield for each instrument. Which instrument offers the investor the highest rate of return if the credit risk is the same?
Solution:
A PV=100 x [1 - 180/360 x 0.0433] = 97.835
AOR= [365/180] x [(100-97.835) / 97.835] = 0.04487
The bond equivalent yield for Bond A is 4.487%
C FV=100 + [100 x (180/360) x 0.0435] = 102.175
AOR= [365/180] x [(102.175-100) / 100] = 0.04410
The bond equivalent yield for Bond A is 4.410%