Computing Realized Compound Yield With A Financial Calculator: A Note

Headnote

ABSTRACT

This note points out that realized compound yield (RCY) has a similar concept from capital budgeting; namely, modified internal rate of return. Recognizing this relationship makes it easier to teach the concept and allows students to easily compute RCY using a financial calculator.

Keywords: yield to maturity; realized compound yield; modified internal rate of return

I. INTRODUCTION

The yield to maturity (YTM) on a bond and the return that bondholders receive when they choose to reinvest the coupons can be a source of confusion to students. Many introductory finance textbooks fail to point out that the YTM, which is the rate that equates the present value of the future cash flows with the price of the bond, makes no assumption about the reinvestment of the coupons. The return that investors earn when all coupons are reinvested is known as the realized compound yield (RCY). Teaching the topic at the introductory level can be difficult because most textbooks ignore the issue.

We begin with a brief review of the realized compound yield and its relationship to the yield to maturity. In Section HI, we show how RCY can easily be computed using a financial calculator. Finally, Section IV concludes the paper.

II. REALIZED COMPOUND YD2LD AND YIELD TO MATURITY

Teaching the concept of RCY can be confusing for students, especially when the discussion is omitted from the textbook. Fortunately, realized compound yield, like yield to maturity, has similar concept from capital budgeting; namely, modified internal rate of return (MIRR). In modified internal rate of return, the cash flows received from the project are assumed to be...