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Yields and Yield Curves
A yield is the income on an investment expressed as a percentage of that investment. The yield is, from the investor's perspective, a measure of return and from the borrower's perspective a measure of cost.
As yields are computed based on different conventions (depending of the source and/or the market where the bond is listed), a clear understanding of the yield used is necessary to be able to compare yields or to bring them back to comparable figures.
One source of difference between the yields is the day count conventions.
DAY COUNT CONVENTIONS
The yields are influenced by day count conventions that differ from one market to the other. Day count conventions differ in assumptions on the number of days in a year as well as the number of days in a month. The most common conventions are:
Actual / 360 days basis
The number of days used in the numerator is the real number of days (as you can find in all calendars). The denominator assumes that you have 360 days (12 times 30 days) in a year.
Yields on commercial papers, treasury bills and other short term instruments are often computed with this convention.
Actual / 365 days basis
Here you use 365 days for the denominator even in a leap year.
This assumption is often use to compute Semi-annual yields. Some examples are treasury notes, treasury bonds, and U.K; Gilts.
30 / 360 days basis
In the convention, all months (even February) are supposed to have 30 days.
Examples are Eurobonds, U.S. domestic corporate bonds and some foreign bonds.
Another source of difference between two yield is the compounding.
Depending of the method used, the yield calculation may or may not include the interest earned on the interest during the year.
Here we find two types of yield:
A nominal yield ignores the compounding of interest.
An effective yield includes the compounding of interest.
In the next section, we will analyze some of the most current yields:
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