Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Coupon Equivalent Rate (CER)

What it is:

The coupon equivalent rate (CER), also known as the bond equivalent yield (BEY), is the effective yield on a zero-coupon bond when calculated as if it paid a coupon.

How it works (Example):

To calculate the coupon equivalent rate, use the following formula:

(Spread between current price and face value / current price) x (365 / time to maturity)
 
Note that some versions of the formula use a 365-day year while others use 360-day year. Both methods are very common.

Let's assume you have a choice between purchasing a $10,000 XYZ Company bond that pays a 5% coupon and matures in 90 days or purchasing a $10,000 zero-coupon bond from Company ABC.

The current price of the zero-coupon bond (issued by ABC) is $9,850, it matures in 90 days, and has a $10,000 face value. Which bond pays a higher interest rate?
 
Using the formula above, we can calculate that the CER of the ABC bond is:

($150/$9,850) x (365/90) = .061759 = 6.18%. By comparing this 6.18% with the 5% interest paid on the XYZ Company bond, we can see that the Company ABC bond pays a higher effective interest rate.

Why it Matters:

Typically, an investor in coupon-paying bonds calculates his or her yield based on the coupon rate and the face value of the bond. But these two bases do not apply to zero-coupon bonds.
 
Although it is important to remember that zero coupon bonds do pay interest, but the issuer pays it out upon maturity instead of every six months. Also, zero-coupon bonds are not sold at face value; they are sold at a discount, and at maturity the investor typically receives more than what he or she invested.
 
Thus, the CER uses the investor's actual initial investment as a basis for calculating yield, allowing the investor to compare yields from zero-coupon with bonds that pay coupons.