Question

What is the discount yield, bond equivalent yield, and effective annual return on a $2 million commercial paper issue that currently sells at 98.25 percent of its face value and is 128 days from maturity? (Use 360 days for discount yield and 365 days in a year for bond equivalent yield and effective annual return. Do not round intermediate calculations. Round your answers to 3 decimal places. (e.g., 32.161))

Answer 1

Answer:

1. Discount yield = 4.92%

2. Dividend yield = 5.07%

3. Effective annual return = 5.02%

Explanation:

The computation of discount yield, bond equivalent yield, and effective annual return is shown below:-

Discount yield

Commercial paper                       $2,000,000

Current selling price                    $1,965,000

($2,000,000 × 98.25%)

Days to maturity                           128

Discount yield ( total days in a year)360

Dividend yield                                   4.92%

($2,000,000 - $1,965,000 ) ÷ $2,000,000 × (360 ÷ 128)

= $35,000 ÷ $2,000,000 × (2.8125)

= 0.0175 × 2.8125

= 0.04921

= 4.92%

Bond equivalent yield

Commercial paper                       $2,000,000

Current selling price                    $1,965,000

($2,000,000 × 98.25%)

Days to maturity                           128

Discount yield ( total days in a year)360

Bond equivalent yield                      5.07%

= ($2,000,000 - $1,965,000 ) ÷ $1,965,000 × (365 ÷ 128)

= $35,000 ÷ $1,965,000 × 2.8515625

= 0.017811705  × 2.8515625

= 0.05079119

= 5.07%

3. Effective annual return

Bond equivalent yield               5.07%

Effective annual return              5.02%

= (1 + 5.07% ÷ 365)^365 -1

= 5.02%