What Is Bond Yield?
Bond yield is the return an investor realizes on a bond and can be derived in different ways.
The coupon rate is the annual interest rate established when the bond is issued. The current yield depends on the bond's price and its coupon, or interest payment.
Additional calculations of a bond's yield include yield to maturity (YTM), bond equivalent yield (BEY), and effective annual yield (EAY).
Key Takeaways
- Bond yield is the return an investor realizes on an investment in a bond.
- A bond can be purchased for more than its face value, at a premium, or less than its face value, at a discount.
- The current yield is the bond's coupon rate divided by its market price.
- Price and yield are inversely related and as the price of a bond goes up, its yield goes down.
Bond Yields: Current Yield And YTM
Understanding Bond Yield
Bonds are essentially a loan to bond issuers. Investors earn interest on a bond throughout the life of the bond and receive the face value of the bond upon maturity.
A bond can be purchased for more than its face value, at a premium, or less than its face value, at a discount, which will change the yield an investor earns on the bond.
Bonds are rated by services approved by the U.S. Securities and Exchange Commission and ratings range from "AAA" as investment grade with the lowest risk to "D," which are bonds in default, or junk bonds, with the highest risk.
The simplest way to calculate a bond yield is to divide its coupon payment by the face value of the bond. This is called the coupon rate.
CouponRate=BondFaceValueAnnualCouponPayment
If a bond has a face value of $1,000 and made interest or coupon payments of $100 per year, then its coupon rate is 10% ($100 / $1,000 = 10%).
Bond Yield vs. Price
Price and yield are inversely related. As the price of a bond goes up, its yield goes down and as yield goes up, the price of the bond goes down.
If an investor purchases a bond with a face value of $1000 that matures in five years with a 10% annual coupon rate, the bond pays 10%, or $100, in interest annually. If interest rates rise above 10%, the bond's price will fall if the investor decides to sell it.
If the interest rate for similar investments rises to 12%, the original bond will still earn a coupon payment of $100, which would be unattractive to investors who can buy bonds that pay $120 as interest rates have risen. To sell the original $1000 bond, the price can be lowered so that the coupon payments and maturity value equal a yield of 12%.
If interest rates fall, the bond's price would rise because its coupon payment is more attractive. The further rates fall, the higher the bond's price will rise.
In either scenario, the coupon rate no longer has any meaning for a new investor. However, if the annual coupon payment is divided by the bond's price, the investor can calculate the current yield and get an estimate of the bond's true yield.
CurrentYield=BondPriceAnnualCouponPayment
The current yield and the coupon rate are incomplete calculations for a bond's yield because they do not account for the time value of money, maturity value,or payment frequency, and more complex calculations are required.
Yield to Maturity
A bond's yield to maturity (YTM) is equal to the interest rate that makes the present value of all a bond's future cash flows equal to its current price. These cash flows include all the coupon payments and maturity value. Solving for YTM is a trial and error process that can be done on a financial calculator, but the formula is as follows:
Price=t−1∑T(1+YTM)tCashFlowstwhere:YTM=Yieldtomaturity
In the previous example, a bond with a $1,000 face value, five years to maturity,and $100 annual coupon payments is worth $927.90 to match a new YTM of 12%. The five coupon payments plus the $1,000 maturity value are the bond's six cash flows.
Finding the present value of each of those six cash flows with an interest rate of 12% will determine what the bond's current price should be.
Bond Equivalent Yield (BEY)
Bond yields are quoted as a bond equivalent yield (BEY),which adjusts for the bond coupon paid in two semi-annual payments. In the previous example, the bonds' cash flows were annual, so the YTM is equal to the BEY.
However, if the coupon payments were made every six months, the semi-annual YTM would be 5.979%. The BEY is a simple annualized version of the semi-annual YTM and is calculated by multiplying the YTM by two.
In this example, the BEY of a bond that pays semi-annual coupon payments of $50 would be 11.958% (5.979% X 2 = 11.958%). The BEY does not account for the time value of money for the adjustment from a semi-annual YTM to an annual rate.
Effective Annual Yield (EAY)
Investors can define a more precise annual yield given the BEY for a bond when considering the time value of money in the calculation. In the case of a semi-annual coupon payment, the effective annual yield (EAY) would be calculated as follows:
EAY=(1+2YTM)2−1where:EAY=Effectiveannualyield
If an investor knows that the semi-annual YTM was 5.979%, they could use the previous formula to find the EAY of 12.32%. Because the extra compounding period is included, the EAY will be higher than the BEY.
Bond Rating
A bond rating is a grade given to a bond and indicates its credit quality. The rating takes into consideration a bond issuer's financial strength or its ability to pay a bond's principal and interest in a timely fashion. There are three bond rating agencies in the United States that account for approximately 95% of all bond ratings and include Fitch Ratings, Standard & Poor’s Global Ratings, and Moody’s Investors Service.
Calculating a Bond's Yield
Some factors skew the calculations in determining a bond's yield. In the previous examples, it was assumed that the bond had exactly five years left to maturity when it was sold, which is rare. The fractional periods can be defined but the accrued interest is more difficult to calculate.
Assume a bond has four years and eight months to maturity. The exponent in the yield calculations can be turned into a decimal to adjust for the partial year.
However, this means that four months in the current coupon period have elapsedwith two remaining, which requires an adjustment for accrued interest. A new bond buyer will be paid the full coupon, so the bond's price will be inflated slightly to compensate the seller for the four months in the current coupon period that have elapsed.
Bonds can be quoted with a "clean price" that excludes the accrued interest or the "dirty price" that includes the amount owed to reconcile the accrued interest. When bonds are quotedin a system like a Bloomberg or Reuters terminal, the clean price is used.
What Does a Bond's Yield Tell Investors?
A bond's yield is the return to an investor from the bond's interest, or coupon, payments. It can be calculated as a simple coupon yield or using a more complex method like yield to maturity. Higher yields mean that bond investors are owed larger interest payments, but may also be a sign of greater risk. The riskier a borrower is, the more yield investors demand. Higher yields are often common with a longer maturity bond.
Are High-Yield Bonds Better Investments Than Low-Yield Bonds?
Bond investment depends on an investor's circ*mstances, goals, and risk tolerance. Low-yield bonds may be better for investors who want a virtually risk-free asset, or one who is hedging a mixed portfolio by keeping a portion of it in a low-risk asset. High-yield bonds may be better suited for investors who are willing to accept a degree of risk in return for a higher return.
How Do Investors Utilize Bond Yields?
In addition to evaluating the expected cash flows from individual bonds, yields are used for more sophisticated analyses. Traders may buy and sell bonds of different maturities to take advantage of the yield curve, which plots the interest rates of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity. They may also look to the difference in interest rates between different categories of bonds, holding some characteristics constant.
A yield spread is a difference between yields on differing debt instruments of varying maturities, credit ratings, issuer, or risk level, calculated by deducting the yield of one instrument from the other such as the spread between AAA corporate bonds and U.S. Treasuries. This difference is most often expressed in basis points (bps) or percentage points.
The Bottom Line
Bond yield is the amount of return an investor will realize on a bond. The coupon rate and Coupon Yield are basic yield concepts and calculations. A bond rating is a grade given to a bond and indicates its credit quality and often the level of risk to the investor in purchasing the bond.
FAQs
A bond's yield is the return an investor expects to receive each year over its term to maturity. For the investor who has purchased the bond, the bond yield is a summary of the overall return that accounts for the remaining interest payments and principal they will receive, relative to the price of the bond.
How is bond yield calculated? ›
Yield is a figure that shows the return you get on a bond. The simplest version of yield is calculated by the following formula: yield = coupon amount/price. When the price changes, so does the yield.
What is yield and how is it calculated? ›
Yield is a return measure for an investment over a set period of time, expressed as a percentage. Yield includes price increases as well as any dividends paid, calculated as the net realized return divided by the principal amount (i.e. amount invested).
What is a bond yield? ›
A bond yield is the amount that an investor makes off a bond investment, also known as the “return on investment.” The “yield” is the return. Let's get into the specifics of bond yields so you can understand more about them, including how they are determined and how to calculate them.
Do bond yields matter? ›
Higher yields mean that bond investors are owed larger interest payments, but may also be a sign of greater risk. The riskier a borrower is, the more yield investors demand. Higher yields are often common with a longer maturity bond.
What is bond yield in simple words? ›
Yield is a general term that relates to the return on the capital you invest in a bond. Price and yield are inversely related: As the price of a bond goes up, its yield goes down, and vice versa.
What makes bond yields go up? ›
This is a function of supply and demand. When demand for bonds declines, issuers of new bonds must offer higher yields to attract buyers, reducing the value of lower-yielding bonds already on the market. This environment hit bondholders hard in 2022. Interest rates tend to follow long-term growth and inflation trends.
How do bond yields affect interest rates? ›
Understanding bond math
When interest rates rise, prices of existing bonds tend to fall, even though the coupon rates remain constant: Yields go up. Conversely, when interest rates fall, prices of existing bonds tend to rise, their coupon remains constant – and yields go down.
Is bond yield the same as interest rate? ›
Yield is the annual net profit that an investor earns on an investment. The interest rate is the percentage charged by a lender for a loan. The yield on new investments in debt of any kind reflects interest rates at the time they are issued.
What factors affect bond yields? ›
The economic factors that influence corporate bond yields are interest rates, inflation, the yield curve, and economic growth. Corporate bond yields are also influenced by a company's own metrics such as credit rating and industry sector.
The low-yield bond is better for the investor who wants a virtually risk-free asset, or one who is hedging a mixed portfolio by keeping a portion of it in a low-risk asset. The high-yield bond is better for the investor who is willing to accept a degree of risk in return for a higher return.
Why do bond yields rise when prices fall? ›
Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price.
How is yield simply calculated? ›
Current Yield
A bond's current yield is calculated by dividing the annual interest payment by the current market price of the bond. Current yield only captures the income generated by the investment. It avoids any changes in value from i.e., either gains or losses.
How do you calculate actual yield? ›
The theoretical yield refers to the amount that should be form when the limiting reagent is completely consumed. The actual yield is expressed as a percentage of the theoretical yield. This is called the percent yield. To find the actual yield, simply multiply the percentage and theoretical yield together.
What is the formula for %yield? ›
Determine the income generated from the investment. Divide the market value by the income. Multiply this amount by 100.
What happens when bond yield goes down? ›
When bond yields fall, it results in lower borrowing costs for corporations and the government, leading to increased spending. Mortgage rates may also decline with the demand for housing likely to increase as well.
What happens to stocks when bond yields rise? ›
This trend is making some equity investors nervous, as all else being equal, higher yields erode the present value of future earnings and hence lower stock market valuations. This relationship is illustrated below.
Do bond yields rise with inflation? ›
Inflation and changing interest rates impact a bond's price. A rise in either interest rates or the inflation rate usually make bond prices drop. Inflation and interest rates move in the opposite direction from bond prices.
Do bond prices go up or down when yields increase? ›
The yield on a bond is its return expressed as an annual percentage, affected in large part by the price the buyer pays for it. If the prevailing yield environment declines, prices on those bonds generally rise. The opposite is true in a rising yield environment—in short, prices generally decline.
Where does the money go when bond yields rise? ›
- Invest in Banks and Brokerage Firms. Banks and brokerage firms earn money from interest. ...
- Invest in Cash-Rich Companies. ...
- Lock in Low Rates. ...
- Buy With Financing. ...
- Invest in Technology, Health Care. ...
- Embrace Short-Term or Floating Rate Bonds. ...
- Invest in Payroll Processing Companies. ...
- Sell Assets.
As the price of a bond goes up, the yield decreases. As the price of a bond goes down, the yield increases. This is because the coupon rate of the bond remains fixed, so the price in secondary markets often fluctuates to align with prevailing market rates.
What controls bond yields? ›
Prices (and therefore effective yields) change for bonds almost constantly. That's because a bond's price is inversely related to yield: When demand is high and Treasury prices rise, yields fall—conversely, when demand is low Treasury prices fall and yields rise.
How do bond yields affect the economy? ›
As bond prices rise, yield on it declines, and vice versa. Government bond yields are indicative of a country's inflation and interest rate expectations. During periods of high inflation, newer debt issuances are compelled to offer higher yields. As interest rates rise, bonds yields can look uncompetitive.
Who benefits from high bond yields? ›
For investors with a high risk tolerance, high-yield bonds may fit their investing goals. These bonds can offer more attractive yields, but they carry more risk and a lower credit rating than investment-grade bonds.
Do high-yield bonds pay interest? ›
Like other types of bonds, when you buy a high-yield bond, you're lending money to the issuer. In exchange, that issuer promises to pay you interest, also known as a coupon, and agrees to pay you back your principal—the bond's face value—when the bond reaches its maturity date.
Is it better to have a higher or lower yield on a bond? ›
The low-yield bond is better for the investor who wants a virtually risk-free asset, or one who is hedging a mixed portfolio by keeping a portion of it in a low-risk asset. The high-yield bond is better for the investor who is willing to accept a degree of risk in return for a higher return.
Is bond yield increase a good thing? ›
Rising bond yields are a negative for bond holders because of the inverse relationship between bond yields and bond prices. When yields rise, prices of current bond issues fall. This is a function of supply and demand.
Are high bond yields good or bad? ›
Rising yields can create capital losses in the short-term, but can set the stage for higher future returns. When interest rates are rising, you can purchase new bonds at higher yields. Over time the portfolio earns more income than it would have if interest rates had remained lower.
Are bond yield increase good or bad? ›
However, rising rates are good for bond “income” or coupon returns. Rising rates mean more income, which compounds over time, enabling bond holders to reinvest coupons at higher rates (more on this “bond math” below). Overall, higher rates offer the potential for greater income and total return in the future.
Why do bond yields fall when interest rates rise? ›
Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price.
Selling in the stock market leads to higher bond prices and lower yields as money moves into the bond market. Stock market rallies tend to raise yields as money moves from the relative safety of the bond market to riskier stocks.
What causes bond yields to rise? ›
A bond's yield is based on the bond's coupon payments divided by its market price; as bond prices increase, bond yields fall. Falling interest interest rates make bond prices rise and bond yields fall. Conversely, rising interest rates cause bond prices to fall, and bond yields to rise.
What are bond yields influenced by? ›
Indian Government Bond Yields are influenced by:-
The monetary policy of the Reserve Bank of India. The course of interest rates. The fiscal position of the government and its borrowing program. Global markets.
Why do bonds do well in a recession? ›
The second reason bonds often perform well during a recession is that interest rates and inflation tend to fall to low levels as the economy contracts, reducing the risk of inflation eating away at the buying power of your fixed interest payments.
What happens to bonds when stock market crashes? ›
When the bond market crashes, bond prices plummet quickly, just as stock prices fall dramatically during a stock market crash. Bond market crashes are often triggered by rising interest rates. Bonds are loans from investors to the bond issuer in exchange for interest earned.
Who has the highest yield government bonds? ›
As of February 21, 2023, the major economy with the highest yield on 10-year government bonds was Nigeria, with a yield of 14.19 percent.
