Discount Yield
The discount yield is a way of calculating a bond's return when it is sold at a discount to its face value, expressed as a percentage. Discount yield is commonly used to calculate the yield on municipal notes, commercial paper and treasury bills sold at a discount.
Definition: Discount yield is a method of calculating the yield on a bond when it is sold at a discount below its face value, expressed as a percentage. Discount yield is commonly used to calculate the yield on municipal notes, commercial paper, and Treasury bills sold at a discount.
Origin: The concept of discount yield originated with the development of the bond market, particularly when governments and corporations issued short-term debt instruments. As financial markets matured, investors needed a way to measure the actual yield of these discount bonds to make better investment decisions.
Categories and Characteristics: Discount yield is primarily applied to the following types of bonds:
- Municipal Notes: Issued by local governments for short-term financing. Discount yield helps investors assess the actual yield of these notes.
- Commercial Paper: Short-term unsecured debt instruments issued by corporations, typically to meet short-term funding needs. Discount yield allows investors to compare the yields of different commercial papers.
- Treasury Bills: Short-term debt instruments issued by the government, usually with a maturity of one year or less. Discount yield is a key metric for evaluating these low-risk investments.
Specific Cases:
- Case One: Suppose an investor purchases a one-year Treasury bill with a face value of $1,000 for $950. The discount yield is calculated as:
Discount Yield = [(Face Value - Purchase Price) / Purchase Price] * 100%. In this example, the discount yield is[(1000 - 950) / 950] * 100% ≈ 5.26%. - Case Two: A company issues a batch of commercial paper with a face value of $100,000, sold at a discount price of $98,000, with a maturity of 180 days. The discount yield is calculated as:
Discount Yield = [(100,000 - 98,000) / 98,000] * (365 / 180) * 100% ≈ 4.08%.
Common Questions:
- Question One: How does discount yield differ from yield to maturity (YTM)?
Answer: Discount yield only considers the purchase price and face value of the bond, while yield to maturity takes into account all cash flows, including interest payments. - Question Two: Why is discount yield particularly important for short-term debt instruments?
Answer: Short-term debt instruments typically do not pay periodic interest, and discount yield provides a simple way to measure the actual yield of these instruments.
