Yield is one of the heaviest topics in CFA level 1. There are many different types of yields which are so confusing. The followings are some of them:

1. Holding Period Yield (HPY) = Earning within the period / initial investment

For example, if a stock is purchased at P0 and sold at P1 with dividend paid D1, the HPY is (P1-P0+D1)/P0. However, it does not annualize the yield.

2. Money Market Yield (MMY) is used to annualize the HPY. However it does not have compounding effect.

MMY = HPY x 360/t

3. Bank Discount Yield (BDY) = Dividend / Face Value X 360 / t

BDY is used to annualize the gain in period t. However, it treats one year as 360 days and the gain is relative to the Face Value instead of the purchasing price. And it does not take compounding into account.

4. Therefore, to have true annualized yield, one should use Effective Annual Yield (EAY).

EAY = (1+HPY)^ (365/t) – 1

5. EAY is the most meaningful yield. But investment community is all about convention! The most important yield in bond market is the Bond Equivalent Yield (BEY). You should be ready to convert any yields to BEY! Since bond coupons are usually paid semi-annually, the yield should be compounded to only half years. And since by convention, bond equivalent yield is quote as 2 X of the half-year yield, BEY is just doubling the half years compounded yield. Therefore to convert HPY to BEY:

BEY = 2 x ((1+HPY)^(365/2t)-1)

Traps and Tips:

Consider this example: if a mortgage backed security has monthly yield of 0.275%, what is the BEY?

BEY = ((1+0.275%)⁶ -1) x 2 = 3.32%

Note that it is compounded monthly up to six months only! Remember the definition of BEY! It’s a must to pass the exam!