The rate of return which is quoted on bonds on the basis of simple interest, i.e., without accounting for the effect of compounding. In most cases, bonds pay interest every six months, and thus the coupon equivalent yield must be compounded semiannually to derive the effective annual yield. The effective annual yield is a measure commonly used by banks in quoting certificates of deposit (CDs). For example, a 10% coupon, $1,000 principal amount bond pays $50 in interest each six months, producing an effective yield of 12.50% (because the first $50 payment each year can be reinvested to earn an additional $2.50 during the second half of the year):

Additional interest earned = 50 × 10%/2 = 2.5%

The objective of calculating the coupon equivalent yield is to establish a yield measure that makes the rate of return on discount securities such as T-bills comparable to that on capital market debt instruments such as coupon-paying bonds. However, the calculation procedure depends on the time to maturity: calculation for discount instruments that have less than six months before maturity differs from calculation for instruments with more than six months left to maturity.

It is also known as a bond equivalent yield (BEY).

For more, see: coupon equivalent yield for discount instruments with more than 6-month maturities and coupon equivalent yield for discount instruments with less 6-month maturities.