Question

2. A corporate treasurer is looking to invest about $4 million for 60 days. Commercial

paper rates are a 3.65% discount and CD rates are 3.66%.

a) (0.4’) What is the CP’s bond equivalent yield?

b) (0.3’) What is the CD’s bond equivalent yield?

c) (0.3’) Which is the better investment?

Answer 1

Solution:
a.	CP’s bond equivalent yield	3.7233	%
Working Notes:
	Commercial paper price
	= Amount invested x (1 - discount rate x (period/360))
	=$4,000,000 x ( 1 - 3.65% x 60/360)
	=$4,000,000 x ( 1 -0.00608333333 )
	=$3,975,666.666667
	CP’s bond equivalent yield
	=((Amount of investment/price) - 1) x (365/period)
	=((4000000/3975666.666667) - 1) x (365/60)
	=0.037233448
	=3.7233%
b.	CD’s bond equivalent yield	3.7108	%
Working Notes:
	First we will calculate price of CD
	CD price
	= amount to be invested x ( 1 + CD rates x period/360)
	=4000000 x ( 1 + 3.66% x 60/360)
	=4024400
	CD’s bond equivalent yield
	=((price/amount invested) - 1 ) x (365/60)
	=((4024400/4000000) - 1 ) x (365/60)
	=0.037108333
	=3.7108%
c.	Investment in Commercial paper is better
Notes:	Higher bond equivalent yield is better and Commercial paper has higher BEY of 3.7233% in comparison of corporate deposit rate 3.7108%
	bond equivalent yields over a 365 day year	is calculated
Please feel free to ask if anything about above solution in comment section of the question.