In this chapter, the emphasis has been on gross yields, which ignore the cost of defaults and investment expenses. In practice, net yields, which are calculated net of the cost of defaults and investment expenses, are often used. In general, the net yield can be calculated as Net yield for the period Investment income for the period

~ Book value at the beginning of period ©

This formula assumes that the asset has cash flows only at the end of the period. Cash flows during the period would require an adjustment to the denominator. Using the notation from Section 14.3.2, the formula for the quarterly net yield would be Seria kegcd BookValcuyeq(—b1, )

1. Using only investment income and book values from Example 14.3.1, QtrNetYield

(b, cyq) =

calculate the quarterly net yield for each period.

2. Using only the annual yield and the annual cost of default and investment expense rates from Example 14.3.1, calculate the annual net yield and convert it to the equivalent quarterly rate.

3. Why do the results from the two previous steps differ? Show algebraically why there is a difference between the two methods of calculating quarterly net yields.

4. What would the result be if the annual default cost and investment expense rates were combined and converted to an equivalent quarterly basis before deducting them from the quarterly yield to determine the quarterly net yield?

5. Which of these methods is most correct?