Association for Financial Professionals (AFP) Practice Exam

Which yield quoting convention is compounded on a 365-day year basis?

1. Bond equivalent yield

2. Money market yield

3. Holding period yield

4. After-tax yield

The correct answer is: Bond equivalent yield

The bond equivalent yield (BEY) is designed to provide a standard yield measure for bond instruments that may be paid semi-annually, allowing for a comparison of yields on different securities and investment types. One of the key aspects of BEY is that it annualizes the yield on a bond based on a 365-day year, making it particularly useful for investors needing to compare bonds with different payment frequencies and maturities. By using the 365-day basis, BEY adjusts for the effects of compounding that would otherwise introduce discrepancies when comparing investment yields that are calculated on different bases. This makes it an essential tool in fixed-income analysis as it represents more accurately the annualized return that an investor can expect from a bond investment. In contrast, the money market yield is typically based on a 360-day year, reflecting the conventions used in short-term money markets. Holding period yield is concerned with the actual return over a specific investment period and does not standardize for 365 days, while after-tax yield incorporates taxation considerations and does not specifically pertain to compounding frequency. Thus, bond equivalent yield stands out distinctly for its use of a 365-day year basis for compounding.