I feel so difficult to convert among EAY, HPY, rmm, and Bond-equivalent yield… Here is the question: A firm is choosing among three short-term investment securities: Security 1 - A 30-day U.S. Treasury bill with a discount yield of 3.6% Security 2 - A 30-day banker’s acceptance selling at 99.65% of face value Security 3 - A 30-day time deposit with a bond equivalent yield of 3.65% A) Prefer 2 B) Indifferent between 2 and 3 C) Prefer 1 D) Prefer 3 Solution: Convert them to basis: Bond equivalent yield Security 1 = discount is 3.6%(30/360) = 0.3% BEY = (0.3/9937)(365/30) = 3.661% BEY of security 2 = (0.35/99365) x (365/30) = 4.273% BEY 3 = 3.65% (given) -------------------------------------------------------------------------------------------- After I read the solution, I have no idea what it is doing. How it convert to BEY. I do not know where the number (e.g. 99.7, 0.35) come from. Please help please help. I am so confuse. Any suggestion to memorize these formulas… so tough
The answer is A btw…
Generally Fixed incomes are issued at par (100 or 1000). Lets take 100 for this example Security 1 : A. 3.6% is discount rate (generally given in a year). so need to convert it in 30 days So 3.6*(30/360)=0.3%. B discount rate for 30 days so at the time of issuance the price of the Bill should be 100%-0.3%=99.7% of value. As it is Treasury bill 30/365 convention is getting used BEY=[(Face value-Purchase value)/Face Value]*(365/t)=[(100-99.7)/100]*(365/30)=3.661% For Sec 2: Same information is given but no need to calculate point A and B as calculated above. Directly put values in equation [(100-99.365)/100]*(365/30)=4.273% HPY (BEY) is high for sec 2 so one should go for Sec2
Patel your explanation is almost right. You just got the equation for BEY wrong. Check the denominator. It is price not facevalue. It does not change that A is right anyway