What is a bond?
A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a fixed interest rate. Interest payments are usually semiannual. The principal of the bond, also known as the face value or par value, is typically repaid at the bond’s maturity date.
What is yield related to bonds?
When you purchase a bond, you are essentially lending money to the bond issuer, which can be a corporation, government, or other entity. In return for loaning your money, you expect to receive interest payments at set intervals, as well as the return of your principal investment when the bond matures. The interest payments you receive are referred to as the bond’s yield.
Yield to Maturity (YTM)
Yield to Maturity (YTM) is the theoretical rate of return of a bond if it is held until its maturity date and held to yield the investor’s desired return. For a bond that pays periodic interest payments, the calculation is based on the assumption that those interest payments are reinvested at the YTM rate. YTM can be thought of as the “internal rate of return” (IRR) of a bond, since reinvesting coupon payments at the YTM rate leads to an overall increase in value equal to the face value or “par value” of the bond. The current yield and YTM are not always equal—the current yield will always be lower than or equal to YTM.
Yield is a measure of the return on an investment in a bond or other fixed-income security. It tells you the percentage of the current market price that you will receive as annual interest payments. The current yield is the simplest and most common way to measure yield. To calculate current yield, divide the bond’s annual interest payments by its current market price.
Yield to Call
Yield to call (YTC) is the yield on a bond calculated using the current market price and assuming the bond will be called at its call price. The call price is usually set at or above par, so a YTC will usually be lower than a yield to maturity (YTM) for a bond with the same coupon rate.
When bonds are issued, they are often issued with a call provision. This provision gives the issuer the right to call, or buy back, the bond at a specified price (the call price) on or after a specified date (the call date). If interest rates have fallen since the bond was issued, the issuer can usually save money by calling the bond and issuing new debt at lower rates. For this reason, investors in bonds with call provisions should be aware that their investments may not have the same duration as they originally anticipated.
When calculating the YTC, it is important to use the market price of the bond rather than its face value. This is because, if the bond is called, investors will only receive the call price, regardless of the face value of the bond. The market price of a bond will fluctuate based on changes in interest rates; as rates fall, prices will rise, and vice versa.
The formula for YTC is as follows:
YTC = C [(1 + y)^n – (1 + i)^n]/[(1 + i)^n(1 + y)]
C = Coupon payments per year
y = Market yield to maturity
i = Call premium rate (% amount by which yield must exceed market yield for investor to break even on purchase)
n = Number of years until call date
How to calculate yield?
To calculate the yield of a bond, you’ll need to know the bond’s current market price, its par value and the coupon rate. The coupon rate is the amount of interest the bond pays per year, expressed as a percentage of the bond’s par value.
Yield to Maturity (YTM)
To calculate a bond’s yield to maturity, input the bond’s face value, coupon rate, number of years until maturity, market price and your desired level of precision. Then, hit the “Calculate YTM” button.
The yield to maturity (YTM) is the discount rate that makes the present value of all future cash flows from a bond equal to its current market price. The cash flows include principal and interest payments. Yield to maturity is also referred to as “redemption yield.”
Current yield is a measure of a bond’s annual interest payment in relation to its current market price. It is represented as a percentage, and can be calculated using the following formula:
Current Yield = Annual Interest Payment ÷ Current Market Price
For example, if a bond has an annual interest payment of $100 and a current market price of $1,000, its current yield would be 10%.
Keep in mind that the current yield does not take into account the bond’s price appreciation or depreciation. Therefore, it’s possible for a bond to have a high current yield but low total return (if the bond’s price falls significantly).
Yield to Call
If you own a bond that pays periodic interest payments, you are not only entitled to those payments, but you will also receive the face value of the bond when it matures. The question then becomes, what if you need that money before the bond matures? One option would be to sell the bond on the market, but another option would be to calculate the yield to call.
The yield to call is the rate of return that an investor would receive if they were to buy a bond and hold it until its call date. The calculation takes into account any interest payments that would be received up until the call date as well as the difference between the purchase price and the call price.
To calculate the yield to call, you will need three pieces of information:
-The current price of the bond
-The call price of the bond
-The coupon rate
Once you have this information, you can use this formula:
Yield to Call = (Coupon Rate – ((Current Price – Call Price) / Years to Call)) / ((Current Price + Call Price) / 2)
Let’s say you purchase a bond for $1,000 with a coupon rate of 5% and a call price of $1,100. The yield to call would be: Yield to Call = (5% – ((1000 – 1100) / 3)) / ((1000 + 1100) / 2) = 4.17%
Find more on bonds here: what is the yield curve? for example.
What factors affect bond yield?
Bond yield is the amount of return an investor will realize on a bond, calculated by the formula: Current Yield = Annual Interest Payment ÷ Current Price. The current yield will fluctuate as the market price of the bond changes. Several factors can affect the market price of a bond and, in turn, its current yield.
Interest rates are one of the most important factors in determining bond yields. When interest rates rise, bond prices fall, and when interest rates fall, bond prices rise. This relationship exists because when interest rates increase, new bonds are issued at a higher coupon rate, making existing bonds with lower coupon rates less attractive to investors. In contrast, when interest rates decline, new bonds are issued at a lower coupon rate, making existing bonds with higher coupon rates more attractive to investors.
Other factors that can influence bond yields include inflation, the creditworthiness of the issuer, and the length of time until the bond matures. Inflationary pressure can cause bond yields to rise as investors demand a higher return for their investment. The creditworthiness of the issuer is also important because it affects the likelihood that the issuer will default on its obligations. For example, bonds issued by the U.S. government are considered to be very safe since there is little risk that the government will default on its obligations. However, bonds issued by corporations are considered to be more risky since there is a greater possibility that the corporation will default on its obligations. Finally, bonds that have a longer time until maturity typically have higher yields than bonds that have a shorter time until maturity since there is more time for changes in market conditions to occur.
Inflation is one of the most important factors that can affect bond yields. When inflation is high, bondholders demand higher interest rates in order to receive a return that keeps pace with the rising cost of living. This in turn causes bond prices to fall and yields to rise.
One of the most important factors affecting the yield on a bond is the credit quality of the issuer. This is because investors demand a higher yield (higher interest rate) to compensate for the increased risk of investing in a company with lower credit quality. For example, a company that is rated AAA by Standard & Poor’s (S&P) is considered to be of very high credit quality, while a company that is rated CCC by S&P is considered to be of very low credit quality.