1) The Effective Annual Yield is usually lower than the Bond Equivalent Yield. True or False

2) According to the CAPM, if the beta of debt equals zero, the expected return of risky debt will equal the risk free rate. True or False.

 

1) False

Effective annual yield is usually greater than the Bond equivalent yield.

Effective annual yield = (1+i/n)ⁿ -1

Bond equivalent yield = (Face value - purchase value)/purchase value )*365/d (d= days to maturity)

For example, if we take Face value = 1000, purchase value = 975 and the coupon is paid semi annually

then Bond equivalent yield = (1000-975)/975) *365/d

then, 2.56 *2 = 0.0513 or 5.12 %

taking the same values and calculating effective annual yield,

= ( 1+5.1%/2)² -1 = 5.16%

Effective annual yield > Bond equivalent yield. So, the above statement is false.

2)True

Because of zero debt beta, the portfolio would have zero correlation with the market movement as the expected return would now be equals to risk free rate.