CFA CFA Level 1 Difference between Effective annual rate and Effective Annual Yield?

Difference between Effective annual rate and Effective Annual Yield?

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  • wannabe1988
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    Hi guys, I am a little confused by the difference between the both.

    The Effective Annual rate has the follow formula, EAR = (1 + periodic rate)^n where periodic rate = Stated annual rate/no of compounding within a year

    vs

    The effective annual yield, EAY = (1 + HPY)^(365/t) – 1

    Can someone help perhaps with an example with how they are differed?

    wannabe1988
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    I think I have understood the difference between EAR and EAY. EAR is used to capture the effect of more than one compounding per year. EAY annualised a yield to make it comparable to other one year yield. 

    I have two new questions now though.

    1) Why is BEY formula BEY=[(1 + EAY)^1/2] – 1? why do you square the first term? Am I right to say BEY function is to restate any yield with monthly, quarterly or semi-annually compounding into one year yield?  

    2)How do you know when to use EAY, money market yield and bond equivalent yield?

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