I understand that Treasury bills are sold at a discount and that the difference between the buying price and nominal value represents the return for the investor. However I am confused with the BEY formula ((Face value – Purchase price)/Purchase price * (365/ days to maturity)) particularly the ”multiplied by 365/d”. Why do we need to annualize the return? Can’t we simply quantify in percentage how much the investor wins (by, say, doing (F-P)/F * 100) ?
In: 0
Because you should always annualize your yield if you want to compare
You’ve got options of three bonds
3 months that returns just 3%
1 year that returns 10%
5 year that returns 20%
If you look at just the absolute return then the answer seems to be the 5 year, but if you just bought the 1 year bond twice in a row you’d end up with more money in just 2 years, and the 3 month bond really returns 80% over the same time
If you look at annualized returns now you can compare them. The 3 month is 12.5%, the 1 year is still 10%, but the 5 year is just 3.7% making it obviously the worse investment. You can also use annualized yield to determine returns over a specific time period like 20 years
Latest Answers