What is the bond-equivalent yield if the monthly cash flow yield is 0.7%?
What will be an ideal response?
The yield on a pass-through must be calculated so as to make it comparable to the yield to maturity for a bond. This is accomplished by computing the bond-equivalent yield, which is simply a market convention for annualizing any fixed-income instrument that pays interest more than once a year. The bond-equivalent yield is found by doubling a semiannual yield. For a
pass-through security, the semiannual yield is
semiannual cash flow yield = (1 + yM)6 – 1
where yMis the monthly interest rate that will equate the present value of the projected monthly cash flow to the price of the pass-through. The bond-equivalent yield is found by doubling the semiannual cash flow yield; that is,
bond-equivalent yield = 2[(1 + yM)6 – 1].
Inserting in our values, we get:
semiannual cash flow yield = (1 + yM)6 – 1 = (1 + 0.007)6 – 1 = 0.0427419 or about 4.274%.
Thus, the bond-equivalent yield is 2[0.0427418] = 0.0854837 or about 8.548%.
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When integrating multiple REA diagrams into an integrated REA diagram, to merge an event that appears in both business cycle REA diagrams,
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