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Fixed Income security question
This question if for Level 1 in fixed income securities. I need help please.
I am having trouble with the conversion from annual to semiannual and converting to quarterly. ( It is section 3.3 Yield measures for fixed-rates bonds. It is the formula for conversion based on periodicity i believe is what i don't understand.
I am assuming that (1.03) to the power of 2 is semiannual. Not sure about (1.03) to the power of 0.5 ( i have no idea why it is 0.5)here is the question: A firm has issued a bond with YTM of 6% on a semiannual basis. What yield should be used to compare it with an annual pay bond and a quarterly pay bond?
|A||For annual pay bond – 6.09%, for quarterly pay bond – 5.96%.|
|B||For annual pay bond – 6.15%, for quarterly pay bond – 5.90%.|
|C||For annual pay bond – 615%, for quarterly pay bond – 6.20%.|
A is correct. A general formula to convert an annual percentage rate for m periods per year, denoted APRm, to an annual percentage rate for n periods per year, APRn, is
For annual pay bond: (1.03)2 - 1 = 6.09%
For quarterly pay bond: (1.03)0.5 - 1 =1.49%.
and for quarterly basis 1.49 * 4 = 5.96%