Final answer:
The discount yield is the yield on a bond when it is purchased at a discount to its face value, bond equivalent yield is calculated as the difference between the face value and the purchase price divided by the purchase price. Whereas, the effective annual return is the annualized return an investor would receive if all interest payments and the face value of the bond were reinvested at the same rate.
Step-by-step explanation:
The discount yield, also known as the bond equivalent yield, refers to the yield on a bond when it is purchased at a discount to its face value. The bond equivalent yield is calculated as the difference between the face value and the purchase price, divided by the purchase price. In the case of the $3 million commercial paper issue selling at 98.00 percent of its face value, the discount yield would be (100 - 98) / 98, or approximately 2.04 percent.
The effective annual return, on the other hand, takes into account compounding. It is the annualized return that an investor would receive if all interest payments and the face value of the bond were reinvested at the same rate. To calculate the effective annual return, you can use the following formula: (1 + discount yield)^(365/days to maturity) - 1. For the $3 million commercial paper issue with 144 days to maturity and a discount yield of 2.04 percent, the effective annual return would be (1 + 0.0204)^(365/144) - 1, or approximately 5.3 percent.