Bond yield is the ROI (Return on Investment) that is reflected as a yearly percentage. For instance, a yield of 5% means that the investment returns a yield of 5% on average every year.
The ROI or yield of a bond can be calculated in a number of ways:
Yield to Maturity requires an intricate calculation and includes the following factors.
When the price of a bond is high, its yield is comparatively lower. It means that an investor has to pay more to obtain the same return from the bond.
Coupon rate –
When the coupon rate of a bond is high, its yield is comparatively higher. This means that the bond will pay a higher percentage of its face value as interest each year.
Period remaining until maturity –
This means that by reinvesting interest payments investors can earn compound interest on their bond investments.
Face value and price difference –
This is a major factor that affects yield to maturity. When an investor retains his bond till maturity, under normal circumstances he receives the bond’s face value, and the amount received is more or less than the price he paid.
Yield to call is the ROI calculated to the next call date instead of the maturity date, using the same calculation to arrive at the yield figure.
Yield to worst is the worst ROI that may accrue to an investor. This situation does not consider a payment default by the issuer.
Bonds with the same yield offering different interest payments:
Sometimes two bonds with similar face value and yield to maturity offer different interest payments. This results from different coupon rates that the two bonds may have. Therefore, an investor purchasing a bond primarily for a regular stream of income should check both the yield to maturity as well as the coupon rate since that could determine his ROI.
Financially and fundamentally strong issuers will always enjoy the confidence of the investors about their ability to pay off the bond at maturity. On the other hand if the issuers display poor fundamental and financial performance they will lose the confidence of the investors and the price of their bonds will fall.
Last Updated on : 10th July 2013