YTM vs Effective Yield

I read an example on L1 where they calculated the I/Y of a semi-annual bond and then to get to the annualized YTM they simply double the I/Y.

However, I would think it is more correct to square (compounding) the I/Y instead of just doubling it.
I mean that the effective yield should be a better measure of return. Do you agree?

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Look at Quant: there are all sorts of measures of return:

  • Bond equivalent yield (BEY)
  • Effective annual yield (EAY) or effective annual return (EAR)
  • Bank discount yield (BDY)
  • Money market yield (MMY)
  • holding period yield (HPY)

Is any one of those a better measure of return than all of the others? Not necessarily. It depends on what you plan to do with the measure you calculate.

Your specific question is asking if EAY is a better measure of return than BEY. No, it isn’t necessarily better, nor is it necessarily worse. It’s simply different.

I understand your point.
But, let me clarify what I meant.
The curriculum teaches us that we should generally “compound” i.e. that the return of 10% for 5 years is not 50%, but it is instead 1.1^5 - 1 = 61%.
So I don’t see why it kind of detracts from this general guideline and not mention that it would be more “appropriate” to compound the semi-annual return to get to the annual return vs. simply doubling the semi-annual return. I haven’t seen it do that. Would you agree with that? Obviously there are many different measures of return but I thought the above calculation more closely followed the “compounding” principle.

How do you define “appropriate”?

Everyone in the bond world quotes yields as BEY. Therefore, it’s “appropriate” to teach candidates how to understand what bond managers are saying, and to be able to talk their language.

Everyone also knows that BEY isn’t an effective yield, and that if you want to know how much your portfolio will be worth in 5 years you need to use an effective yield. But talking about EAY when everyone else in the room is talking about BEY will be harmful, and can lead to stupid, costly errors.

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(1+ semi-annual result)2 - 1 = effective annual rate

semi-annual result * 2 = nominal rate compounded semi-annually

As long as the rates are used in a consistent manner, PV and FV will be the same under either rate. :nerd_face: