Isn’t it more useful (and correct) in practice to calculate the effective yield of each bond?
I see in some cases we simply see what the 6-month rate is and then we simply double that to get to the annualized YTM. However, that doesn’t seem to be “correct” to me. The effective rate seems more correct as it uses compounding to get the yearly rate from the 6-month rate.
Do you agree?
However, when asked in CFA questions, unless we are asked specifically to calculate the effective rate, then we should simply calculate the YTM using the first method (6 month-yield x 2) and not the effective yield, isn’t that correct?
The convention in fixed income is to quote bond equivalent yield (BEY). The reason is that most bonds pay coupons semiannually, and each coupon payment is half the stated (annual) coupon rate; if yields were quoted as effective annual yield, then the yield on a par bond would not be the same as its coupon rate.
Like it or not, that’s the convention; there’s nothing you nor I can do about it.
I know some of you out there like the “6 month rate * 2” approach and others go with the BEY (nominal semi-annual) approach. Both work and the BA II calculator can handle either approach. Just make sure you are familiar with the method you choose and how to enter values into your calculator. 