Calculating Bond Yields

While tax implications are important, most Unlike a stock yield, a bond yield not only
people are probably more concerned with the reflects your return in the form of income, but
pre-tax return on their investments. In the case also includes any capital gain or loss realized
of bonds, that means knowing how to work out when the bond matures. So, a bond yield to
what’s known as the bond’s yields. maturity is made up partly of income and partly
of capital gain or loss.
So, let’s start with a couple of definitions. A
$10,000 bond that you buy for $10,000 is said The bond you bought for $9,500 will mature
to have been bought at par. A $10,000 bond and pay you $10,000, giving you a capital gain
that you buy for less than par, say $9,500, is of $500. The bond you bought for $11,000 will
said to have been bought at a discount. While a also mature and pay you $10,000, leaving you
$10,000 bond you buy for more than par, say with a capital loss of $1,000.
$11,000, is said to have bought at a premium.
Approximate Yield to Maturity
Current Yield A more precise bond yield can be determined
Current yield is the annual income expressed as by averaging the purchase price with the
a percentage of the cost or market price. All redemption price, which is par or $100. The
bond yields are calculated based on $100 par, formula for approximate yield to maturity is:
regardless of how large a bond an investor interest income + annual price change
holds. So if a bond has a coupon of 8% and you × 100
(purchase price + 100) ÷ 2
paid $10,000 for it, your current yield is:
8 ÷ 100 = 8% For example, let’s calculate the yield on a 10%
$5,000 bond maturing in eight years that was
But if you paid $11,000 for the bond your purchased at $92.
current yield would be: ü What is the annual interest income based on
8 ÷ 110 = 7.27% $100 par?
Conversely, if you paid $9,500 for the bond, $100 × 10% = $10
your current yield would be: ü What is the annual price change based on
8 ÷ 95 = 8.42% $100 par?

Current yield is a useful measure, as it can be The bond was purchased at $92 and will
compared to the current yield of other mature at $100. So, it will increase over the
investments such as income trusts or preferred remainder of its life by $8.00. Since there
shares. However, if you intend to hold the bond are eight years to maturity, the annual price
to maturity, current yield is not so useful as it increase of this bond will be $1.00 per year.
changes everyday based on the current price of
the bond. An investor intending to hold a bond ($100 − $92) ÷ 8 = $1
until maturity has locked in the final price of
the bond already – par. ü What is the average price based on $100
par?
Yield to Maturity
But, with most bonds, this relationship is The purchase price was $92 and the bond
complicated by the assumption that you’ll be will mature at $100. The average price then
repaid the par value of your investment at equals:
maturity.
($92 + $100) ÷ 2 = $96
All pre-written articles are for the exclusive use of practising FCSIs and remain the property of CSI Global Education (2003). Unauthorized use or duplication of these
articles by persons who are not practising FSCIs is prohibited and subject to penalties provided by law.

© CSI Global Education Inc. (2003)

 Therefore, the approximate yield to What are these yields telling you?
maturity on a 10% $5,000 bond maturing in When you’re buying a bond, your investment
eight years that was purchased at $92 is: advisor will quote you the price, years to
maturity, the coupon rate, the bond’s current
$10.00 + $1.00
× 100 yield and yield to maturity. These quotes will
($92 + $100) ÷ 2
tell you different things. First, the coupon rate
$11.00 will tell you how much income you will receive
× 100 = 11.46%
$96 per year. The current yield will tell you how
much interest income you will receive in
Yield to Maturity using the Present Value relation to the price you’re paying for the bond.
Method The yield to maturity will estimate the total
Remember, though, that this is a rough method return of the bond, assuming you don’t sell it
of calculating yields and your investment prior to maturity and that all coupon payments
advisor will communicate to you a much more are reinvested. Don’t forget that the
precise yield calculation using the present value approximate yield to maturity is just that, an
method rather than the approximate yield to approximation and it won’t be your actual
maturity method. The present value method return.
calculates the present value of all the cash
flows (interest and principal) an investor will The more precise yield to maturity figure, using
receive over the life of the bond. This yield is present value methodology is a more accurate
the one that is reported in the newspaper and is measure of the return you are earning on the
the one used when trading in the bond market. bond, but it too, assumes that you can reinvest
the interest income at the same rate. Your
Why do bond prices move in the opposite actual return will be determined by a number of
direction of bond yields? factors, including whether you are going to
When a bond is first sold as a part of a new spend your interest income or reinvest it and at
issue, the price is fixed. From then on, the price what rate.
of a bond moves up or down relative to changes
in the general level of interest rates. When Hopefully, the term yield and its numerous
interest rates rise, the price of a bond goes meanings have been clarified. But, just to be on
down because its coupon rate (the fixed, the safe side, talk to your investment advisor.
periodic payment) becomes less appealing in The yield of a bond is only one of the many
comparison to the higher coupon rates of newly factors you should consider when choosing an
issued bonds of similar quality. Conversely, if investment in bonds.
interest rates fall, the bond's coupon rate
becomes more attractive to investors, which
drives up the price.

If the yield to maturity is greater than the

coupon rate, the bond will sell at a discount to
its maturity price. If the yield to maturity is less
than the coupon rate, the bond will sell at a
premium to its maturity price. Also, the longer
the maturity of the bond, or the smaller the
coupon rate, the more its price tends to be
affected by changes in interest rates.

All pre-written articles are for the exclusive use of practising FCSIs and remain the property of CSI Global Education (2003). Unauthorized use or duplication of these
articles by persons who are not practising FSCIs is prohibited and subject to penalties provided by law.

© CSI Global Education Inc. (2003)