Updated Feb 09, 2022

What is Bond yield?

What is a bond yield?

A bond's yield is a percentage of interest rate that expresses the expected earnings and returns on a fixed-income investment over a specific period. The yield on a bond is calculated in various ways, each revealing a different aspect of the bond's potential risk and reward. When you buy bonds, you effectively lend money to the company issuing them. As long as a bond is outstanding, its issuers promise to pay interest to bondholders and then return the principal to investors. A bond's yield can be calculated by dividing its coupon payment by its face value. The coupon rate is a term for this.

Calculating bond yield

A bond's yield tells you how much money you'll get back if you hold it. The following formula is used to calculate the simplest form of output: Coupon value divided by price equals yield. The yield fluctuates in lockstep with the market's price movements.

Different types of yields

Bond yields come in a variety of forms:

Running yield: To calculate a bond's running yield, divide the current market value by

the yield.

Nominal Yield: The rate of the interest you can expect to earn annually from a bond's coupon or coupon yield.

Yield to maturity: A bond's yield to maturity (YTM) tells you how much interest you'll get if you hold on to your investment until it matures.

Tax equivalent yield: The tax-equivalent yield (TEY) lets you compare tax-exempt bonds to bonds that aren't. You can do this by taking the yield on the tax-exempt bond and dividing it by [one minus your tax rate].

Yield to call: Long-term interest is calculated using the "call date," which is the date and price of the bond on which you have the right to sell it before its maturity; this method is known as Yield to Call (YTC).

Yield to worst: The Yield to Worst (YTW) measures the bond's potential return to investors by comparing it to the lowest of the two outputs, the YTM or YTC.

Securities and exchange commission yield: The Securities and Exchange Commission calculates the expected result on a bond based on historical data.

Why pay attention to the yield on a bond?

In the financial world, the yield on a bond is the amount of money an investor gets back in coupon payments. When calculating a simple coupon yield, there is no consideration for the time value of money, changes in the bond price, or a more complex method like yield to maturity. There are advantages and disadvantages to investing in bonds, both of which impact interest payments to bondholders. The higher the product investors require to hold a borrower's debt, the riskier the borrower is. Investing in longer-term bonds is associated with a higher yield.

Do investors use bond yields in a different way?

Additional analysis is done using the yields of individual bonds. With the help of the yield curve, which depicts interest rates for bonds of similar credit quality but different maturities, traders can buy and sell bonds with different terms. Interest rates and economic activity can be predicted using the yield curve's slope. They could also look at the difference in interest rates between different types of bonds as a possible risk indicator while keeping other characteristics constant.

Price and yield are intertwined

The following equation summarises the relationship between yield and price: When the cost of an asset rises, the product decreases, and the opposite is true. In a purely mathematical sense, the development and price of a bond are inversely related.

Effect of interest rate on bond yield

The level of interest rates in the economy is an important factor in determining the value of a bond. Lowering bond prices and rising yields are two ways that rising interest rates impact the value of bonds. Bond prices rise as interest rates fall, bringing down the yield on older bonds and in line with newer bonds' lower coupons.

Conclusion

Bond yields can be used in many different ways. They can elaborate the amount of profit you can earn on a bond compared to other investments. High bond yield signifies high bond risk due to less investment by the investors, and this would make the bond more effective in comparison to other bonds as it results in an increased amount of output.