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Appendix I The General Redemption Yield Formula The redemption yield y of a security, compounded annually, is given by solving an equation of the form

where:P =gross price (i.e. clean price plus accrued interest) n =number of future cash flows, where n may be infinite CFi=ith cash flow Li =time in years to the ith cash flow, taking into account the market conventions for calculating the fraction of a year. (e.g. does the year have 360 or 365-days). v =discounting factor i.e. v = 1/(1 + y) y =required redemption yield compounded annually (y = 0.08 for a yield of 8%). This general redemption yield formula, which assumes that all cash flows irrespective of their timing are discounted at the same rate, works for all securities. In the case of partly paid issues, future price calls are regarded as negative cash flows. Similarly for undated bonds n is infinite, as it is assumed that the issuer never defaults. In chapter 4 we stated that the modified duration MD of a bond was given by:

where: P = gross price (i.e. clean price plus accrued interest) dp = small change in price dy = corresponding small change in yield

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