Professional Documents
Culture Documents
By JAMES CHEN
KEY TAKEAWAYS
The nominal yield does not always represent the annual return because it's a
percentage based on the bond's par value, and not the actual price that was paid
to buy that bond. Buyers who pay a premium that's more than the face value for
a given bond will receive a lower actual rate of return than the nominal yield,
while investors who pay a discount that's less than the face value will receive a
higher actual rate of return. It's also worth noting that bonds with high coupon
rates tend to get called first—when callable—because they represent the issuer's
greatest liability relative to bonds with lower yields.
For example, a bond with a face value of $1,000 that pays the bondholder $50 in
interest payments annually would have a nominal yield of (50/1000) of 5%.
If the bondholder bought the bond for $1,000 then the nominal yield and
the annual rate of return are the same, 5%.
If the bondholder paid a premium and bought the bond at $1,050, then the
nominal yield is still 5% but the annual rate of return would be 4.76%
(50/1050).
If the bondholder got the bond at a discount and paid $950 then the
nominal yield is still 5% but the annual rate of return would be 5.26%
(50/950).