Question

1. Why do DRY and the IRY result in different values? Explain why this difference, even though seemingly small, can be very important?

2. How might a firm use the issuance of commercial paper as a way to deal with its seasonal fluctuations in sales?

3. Assume you are going to buy a 90-day Treasury Bill with a face value of $1,000 for a price of $944. Calculate the DRY, or discount rate yield. Also, calculate the IRY, or investment return yield.

Answer 1

Since, multiple questions have been posted, I have answered the first one and last one (relating to DRY and IRY) as they are related to each other.

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Question 1:

The DRY and IRY differ in values because of the base/reference with respect to which these yields are calculated. The formula for calculating each yield is given below:

DRY (Discount Rate Yield) = (Face Value of Treasury Bills - Price Paid for Treasury Bills)/Face Value of Treasury Bills*360/Period

IRY (Investment Rate Yield) = (Face Value of Treasury Bills - Price Paid for Treasury Bills)/Price Paid for Treasury Bills*360/Period

As can be seen from the above formula that DRY uses face value as the basis for calculating yield. IRY, on the other hand uses the price paid as the basis for determining yield.

Let us calculate the two yields by taking an example for a 60-day Treasury Bill. Assuming that the face value of treasury bill is $1,000 and the price paid by the investor for this treasury bill is $995.

DRY = (1,000 - 995)/1,000*360/60 = 3.00%

IRY = (1,000 - 995)/995*360/60 = 3.02%

As can be seen from the above calculations that the difference between DRY and IRY is very small. However, the difference is important because the investors would be interested in knowing the return earned (by them) on the amount actually paid by them rather than the face value of treasury bills. Therefore, IRY will appear to be more valuable to the investors.

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Question 3:

The DRY and IRY are calculated as follows:

DRY (Discount Rate Yield) = (Face Value of Treasury Bills - Price Paid for Treasury Bills)/Face Value of Treasury Bills*360/Period = (1,000 - 944)/1,000*360/90 = 22.40%

IRY (Investment Rate Yield) = (Face Value of Treasury Bills - Price Paid for Treasury Bills)/Price Paid for Treasury Bills*360/Period = (1,000 - 944)/944*360/90 = 23.73%