CFA CFA Level 1 EAY vs EAR – what’s the difference?

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EAY vs EAR – what’s the difference?

  • This topic has 2 replies, 2 voices, and was last updated 2w by gontata.
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  • gontata
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    Can someone help me understand what are the differences between effective annual yield (EAY) and effective annual rate (EAR)? Is there actually a difference between EAY vs EAR or are they the same thing?

    mikey
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    The concept of both is the same thing – calculating the annualized return rate of a security.

    Effective annual yield (EAY) usually calculates the annualized holding period yield (HPY) or yield to maturity (YTM), which is the return earned when a security is held until maturity. Remember that EAY:

    • (Usually) assumes 365 days in a year
    • Incorporates compounding

    Formula:

    EAY=1+HPY365t1

     

    where HPY = holding period yield (or YTM)

    Effective annualized rate (EAR) is usually converting a % rate (e.g. nominal 8% paid quarterly) to a rate that indicates the actual interest paid when compounding is taken into account. EAR tends to ‘scale up’ or ‘scale down’ payment periods such as semi-annually, quarterly, etc.

    So for a nominal 8% rate paid quarterly:

    Formula:

    EAR=1annual nominal rate# payments a year# payments a year=10.0844=8.24%
    gontata
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    Thanks for the thorough answer, this helps a lot!

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