What Is a Bond Yield?
Let me explain bond yield directly: it's the return you get on the money you've invested in a bond. When a bond is first issued, its yield matches the coupon rate, but that yield can shift as the bond trades in the market. You can calculate bond yields in several ways, such as through coupon yield or current yield.
Key Takeaways
Bond yield is straightforward—it's what you earn as an investor from holding a bond. You might buy a bond above its face value at a premium or below at a discount, which affects your yield. The current yield comes from dividing the bond's coupon rate by its current market price. Remember, price and yield move in opposite directions: when the bond's price rises, its yield falls.
Understanding Bond Yields
Think of a bond as a loan you make to the issuer—they're generally safe because their values don't swing like stocks, offering you a steady income stream. You'll get interest payments over the bond's life and the face value back at maturity. If you buy at a premium or discount, that changes your effective yield. Bonds get rated by SEC-approved services, from AAA for low-risk investment grade to D for high-risk junk bonds in default. The yield you realize is key, and there are types like coupon yield, which is the fixed annual rate from issuance, and current yield, which varies with the bond's price and coupon payments.
Formula and Calculation of a Bond Yield
The basic way to figure out bond yield is dividing the annual coupon payment by the bond's face value—that's the coupon rate. For example, if a $1,000 bond pays $100 yearly, the coupon rate is 10%. But that's just the start; more on advanced calculations later.
Bond Yield vs. Bond Price
Price and yield are inversely linked—as the price increases, yield decreases, and vice versa. Take a $1,000 bond with a 10% coupon paying $100 annually, maturing in five years. If rates rise to 12%, you'd need to lower the price to make it yield 12% for a buyer. If rates drop, the price rises because the $100 payment becomes more valuable. Current yield is annual coupon divided by current price, but it doesn't capture time value or maturity fully— you need more complex methods for that.
Additional Bond Yield Calculations
Beyond basics, consider yield to maturity (YTM), which equals the rate making the present value of future cash flows match the current price—it's trial and error, but the formula involves coupon, face value, present value, and time. Bond equivalent yield (BEY) annualizes semi-annual yields by doubling them, ignoring time value. Effective annual yield (EAY) factors in compounding for a more accurate annual rate.
Bond Yield Calculation Issues
Calculations can get tricky with partial years to maturity, like four years and eight months, requiring adjustments for accrued interest. Bonds are quoted with clean prices excluding accrued interest or dirty prices including it—systems like Bloomberg use clean prices.
Frequently Asked Questions
What does a bond's yield tell you? It's your return from coupon payments, calculable simply or via YTM; higher yields mean bigger payments but often more risk, especially with longer maturities. Are high-yield bonds better than low-yield? It depends on your risk tolerance—low-yield for safety, high-yield for potential returns. High-yield are indeed junk bonds, riskier but with higher payouts. You can use yields for analysis like trading the yield curve or spreads between bond types to gauge economic trends.
The Bottom Line
Bond yield is your return on a bond, with basics like coupon and current yield, plus advanced ones like YTM and BEY. Ratings indicate credit quality and risk, helping you assess if a bond fits your strategy.
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