Fixed income instrument

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Fixed income instrument

Postby chandniwadhwani92 » Sun Oct 12, 2014 7:40 am

Difference between annualized effective yield and annualized add on yield

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Fixed income instrument

Postby edupristine » Mon Oct 13, 2014 7:50 am

Annualized Effective Yield
The yield after taking account the consequences of compounding is the annualized effective yield. For eg. If one has a fixed income asset that pays 3% interest monthly, then the annualized percentage yield is more than 3% because here the interest is compounded monthly which results in a higher return each month. In this example,
Annualized effective yield = (1.03)^12 – 1 =0.43 or 43%, where 12 is the no of compounding periods.
Add On Yield
Add on yield is used in case of Eurodollar contracts and many other money market instruments. It is expressed as annualized interest divided by original principal and expressed as a percent.
The yield on a euro dollar contract is quoted on an add- on basis as follows:
Add on yield = ($Discount/Price)(360/DTM)
Where DTM = Days until maturity, and DY is the discount yield.
$Discount = [DY (Face Value) (DTM)]/360
Price = Face Value - $Discount

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