Fundamentals of Financial Services

CALCULATIONS

1. Calculate EAR

2. Calculate DIVIDEND YIELD

3. Calculate FLAT YIELD

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1. Calculate EAR - notes
Be able to calculate the effective annual rate of borrowing, given the
quoted rate and frequency of payment

Quoted Rate EAR

Effective Annual Rate
This is normally the interest rate Takes the quoted rate and adjusts it to
advertised by the bank. take into account the frequency of
interest charges.
By law lenders have to show this rate to
customers. Often, interest is not charged once a year
but on a quarterly or monthly basis
It is used so that customers can easily
compare financial products. The EAR is higher than the quoted rate
(APR)
The quoted rate shows the cost of
borrowing if interest is charged on an
annual basis.

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1. Calculate EAR - example
Be able to calculate the effective annual rate of borrowing, given the
quoted rate and frequency of payment

What is the effective annual rate if the quoted rate is 6% and

interest is charged quarterly? 1. Take the quoted rate and divide it by the
Opening Interest Closing frequency with which interest is charged:
Month Balance Rate Interest Balance
6% / 4 = 1.5%
January 1,000.00 1,000.00
February 1,000.00 1,000.00 2. Turn the interest rate into a decimal:
March 1,000.00 1.50% 15.00 1,015.00 1.5% / 100 = 0.015
April 1,015.00 1,015.00 3. Add one to the decimal:
May 1,015.00 1,015.00
June 1,015.00 1.50% 15.23 1,030.23 0.015 + 1 = 1.015
July 1,030.23 1,030.23 4. Multiply this number to the power of the
August 1,030.23 1,030.23
number of times interest is charged:
September 1,030.23 1.50% 15.45 1,045.68 1.015 to the power of 4
October 1,045.68 1,045.68 (1.015 x 1.015 x 1.015 x 1.015)
November 1,045.68 1,045.68
December 1,045.68 1.50% 15.69 1,061.36
= 1.0613634
5. Minus the one and turn the number back
into a percentage:
1.0613634 – 1 = 0.0613634
0.0613634 x 100 = 6.14% EAR
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 1. Calculate EAR – practise questions
Be able to calculate the effective annual rate of borrowing, given the
quoted rate and frequency of payment
Question: Question:
A credit card company is quoting a flat rate of annual A £5,000 loan is taken out over a three year period by a
interest at 18% per annum, charged half-yearly. What is higher rate taxpayer. If the quoted interest rate is 8% p.a.,
the effective annual rate? Calculate to 2 dp charged on a quarterly basis, what is the effective annual
rate of borrowing. Calculate to 2 dp

Question:
Jane borrows £100 from Happy Paydays at a quoted rate of
annual interest of 50% calculated on a monthly basis. What is
Jane’s effective annual rate of interest? Calculate to 1 dp

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 1. Calculate EAR – ANSWERS
Be able to calculate the effective annual rate of borrowing, given the
quoted rate and frequency of payment
Question: Question:
A credit card company is quoting a flat rate of annual A £5,000 loan is taken out over a three year period by a
interest at 18% per annum, charged half-yearly. What is higher rate taxpayer. If the quoted interest rate is 8% p.a.,
the effective annual rate? Calculate to 2 dp charged on a quarterly basis, what is the effective annual
rate of borrowing. Calculate to 2 dp
18% charged half-yearly (twice a year)
18%/2 = 9% charged every 6 months 8% charged quarterly (four times a year)
9/100 = 0.09 8%/4 = 2% charged every 3 months
1+0.09 = 1.09 2/100 = 0.02
1.09 to the power of 2 (times interest charged in a year) = 1.1881 1+0.02 = 1.02
1.1881 – 1 = 0.1881 1.02 to the power of 4 (times interest charged in a year) =
0.1881 x 100 = 18.81% EAR 1.0824321
1.0824321 – 1 = 0.824321
Question:
0.824321 x 100 = 8.24% EAR
Jane borrows £100 from Happy Paydays at a quoted rate of
annual interest of 50% calculated on a monthly basis. What is
Jane’s effective annual rate of interest? Calculate to 1 dp
50% charged monthly (twelve times a year)
50%/12 = 4.1666666% charged monthly
4.1666666/100 = 0.0416666
1+0.0416666 = 1.0416666
1.0416666 to the power of 12 (times interest charged in a year) = 1.63209287928
1.63209287928 – 1 = 0.63209287928
0.63209287928 x 100 = 63.2% EAR

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2. Calculate DIVIDEND YIELD - notes
Be able to calculate the dividend yield

Comparing dividends with other potential investments

Potential shareholders will compare the dividend paid on a company’s shares with
alternative investments e.g. other shares, bonds and bank deposits.

Calculating the Dividend Yield:

Total Dividends or Dividend per share
Dividend Yield = Market Capitalisation or Share Price
X 100
(Total value of the company’s shares)
2. Calculate DIVIDEND YIELD - example
Be able to calculate the dividend yield

Comparing dividends with other potential investments

Potential shareholders will compare the dividend paid on a company’s shares with
alternative investments e.g. other shares, bonds and bank deposits.

Calculating the Dividend Yield:

Total Dividends or Dividend per share
Dividend Yield = Market Capitalisation or Share Price
X 100
(Total value of the company’s shares)

Example:
BT has 20 million ordinary shares, each trading at £2.50. BT pays out a total of £1m in
dividends.
£1m
Dividend Yield = X 100
20m x £2.50
£1m
Dividend Yield = X 100
£50m
Dividend Yield = 2%
2. Calculate DIVIDEND YIELD – practise questions
Be able to calculate the dividend yield

Total Dividends or Dividend per share

Dividend Yield = Market Capitalisation or Share Price X 100
(Total value of the company’s shares)

Question:
A company paid dividends of $10.20 per share in each of the last four quarters. The share
price is currently $357. What is the dividend yield? Calculate to 2 decimal places

Question:
RM Inc paid four quarterly dividends of 75 cents per share in the last year. RM shares are
currently trading at $90 each, having traded at a high of $95 in the last year. What is the
current dividend yield to 2 decimal places?
2. Calculate DIVIDEND YIELD – ANSWERS
Be able to calculate the dividend yield

Total Dividends or Dividend per share

Dividend Yield = Market Capitalisation or Share Price X 100
(Total value of the company’s shares)

Question:
A company paid dividends of $10.20 per share in each of the last four quarters. The share
price is currently $357. What is the dividend yield? Calculate to 2 decimal places
Dividend = $10.20 x 4 = $40.80
Dividend yield = ($40.80/$357) x 100
Dividend yield = 0.1142857 x100
Dividend yield = 11.43%
Question:
RM Inc paid four quarterly dividends of 75 cents per share in the last year. RM shares are
currently trading at $90 each, having traded at a high of $95 in the last year. What is the
current dividend yield to 2 decimal places?
Dividend = $0.75 x 4 = $3
Dividend yield = ($3/$90) x 100
Dividend yield = 0.0333333 x100
Dividend yield = 3.3%
 BONDS
The Relationship Between Bond Prices and Bond Yields
There is an INVERSE RELATIONSHIP between BOND PRICE and BOND YIELD when
bonds are traded
£10,000 nominal of a 5%Treasury2022 is issued in
2018 Interest Bond
Rates Yield
In 2020 interest rates are 4% - bondholder needs to
sell

Bond price increases from £100 per £100 nominal to

£110 per £100 nominal Bond
Bondholder sells the bond for £11,000 (£110 x £100) Price

Original yield is 5% (same as coupon when issued)

New yield = (5%/110) x 100 = 4.54%
 BONDS
The Relationship Between Bond Prices and Bond Yields
There is an INVERSE RELATIONSHIP between BOND PRICE and BOND YIELD when
bonds are traded
£10,000 nominal of a 5%Treasury2022 is issued in 2018
Interest Bond
In 2020 interest rates are 6% - bondholder needs to sell Rates Yield
Bond price decreases from £100 per £100 nominal to
£90 per £100 nominal
Bondholder sells the bond for £9,000 (£90 x £100)

Original yield is 5% (same as coupon when issued) Bond

Price
New yield = (5%/90) x 100 = 5.55%
3. Calculate FLAT YIELD – notes
Be able to calculate the flat yield of a bond

An investor may not have paid the par value – they may have paid a different amount to purchase
the bond, so a method of calculating the true return to him or her is needed.
Flat yield

The most straightforward yield is to look at the coupon paid on a bond as a

percentage of its market price – known as the flat or running yield

Annual coupon
Flat yield (%) = X 100
Bonds market price
(Price paid to purchase £100 nominal)
3. Calculate FLAT YIELD - example
Be able to calculate the flat yield of a bond

An investor may not have paid the par value – they may have paid a different amount to purchase
the bond, so a method of calculating the true return to him or her is needed.
Flat yield

The most straightforward yield is to look at the coupon paid on a bond as a

percentage of its market price – known as the flat or running yield

Annual coupon
Flat yield (%) = X 100
Bonds market price
(Price paid to purchase £100 nominal)

Question:
A bond with a coupon of 5%, redeemable in 2030, is trading at £82 per £100 nominal.
What would be the flat yield on this bond (rounded to 2 decimal places):

(5/£82) x 100 = 0.060975609756 x 100

Flat yield = 6.10% (to 2 dp)
3. Calculate FLAT YIELD – practise questions
Be able to calculate the flat yield of a bond

Annual coupon
Flat yield (%) = X 100
Bonds market price
(Price paid to purchase £100 nominal)

Question:
What is the flat yield on a 3.5% Treasury bond with five years to redemption and
currently trading at £97? Calculate to two decimal places.

Question:
A client holds an 8% bond which matures in 2022. It is currently trading at £124. What is
the flat yield? Calculate to two decimal places.

Question:
A 6% bond issued by ABC plc redeemable in 2020 is currently trading at £107. What is
the flat yield? Calculate to two decimal places.
3. Calculate FLAT YIELD – ANSWERS
Be able to calculate the flat yield of a bond

Annual coupon
Flat yield (%) = X 100
Bonds market price
(Price paid to purchase £100 nominal)

Question:
What is the flat yield on a 3.5% Treasury bond with five years to redemption and
currently trading at £97? Calculate to two decimal places.
(3.5/£97) x 100 = 0.0360824 x 100
Flat yield = 3.61% (to 2 dp)
Question:
A client holds an 8% bond which matures in 2022. It is currently trading at £124. What is
the flat yield? Calculate to two decimal places.
(8/£124) x 100 = 0.06451661 x 100
Flat yield = 6.45% (to 2 dp)
Question:
A 6% bond issued by ABC plc redeemable in 2020 is currently trading at £107. What is
the flat yield? Calculate to two decimal places.
(6/£107) x 100 = 0.0560747 x 100
Flat yield = 5.61% (to 2 dp)