Yield Basis: What It Means and How It Works

The yield basis is a method of quoting fixed‑income securities (such as bonds) as a yield percentage rather than as a dollar price. Quoting by yield makes it easier to compare bonds with different coupon rates, prices, maturities, and credit qualities.

How yield basis is calculated (current yield)

Current yield = Annual coupon payment ÷ Purchase price

Example:
– Par value: $1,000
– Coupon rate: 6.75% → annual coupon = $1,000 × 6.75% = $67.50
– Market price: $940
– Current yield = $67.50 ÷ $940 = 0.0718 = 7.18%

Interpretation:
– If the yield basis > coupon rate → the bond is trading at a discount.
– If the yield basis < coupon rate → the bond is trading at a premium.

Note: Current yield is a simple measure of income relative to price; it does not capture total return if the bond is held to maturity (that is measured by yield to maturity, or YTM).

Bank discount yield (for discount instruments and T‑bills)

For pure discount instruments (no coupons), markets often use the bank discount yield:

Bank discount yield r = (Discount ÷ Par value) × (360 ÷ t)

Where:
– Discount = Par value − Purchase price
– t = days to maturity
– 360 = market convention for days in a year

Example (Treasury bill):
– Par value: $1,000
– Purchase price: $970 → Discount = $30
– Time to maturity: 180 days
– r = ($30 ÷ $1,000) × (360 ÷ 180) = 0.06 = 6%

Key points:
– Bank discount yield expresses the discount as a fraction of par (not of the purchase price).
– It assumes simple interest (no compounding).
– Treasury bills are quoted on a bank discount basis.

Special considerations for buyers

• Net yield basis vs. gross price: On the secondary market, brokers may sell bonds on a net yield basis, meaning the quoted yield already includes the broker’s markup. Alternatively, some brokers charge a separate commission or execution fee.
• Always ask whether a quoted yield is net (includes broker profit) or whether additional fees apply (commissions, broker‑assisted fees).
• Accrued interest: When buying a bond between coupon dates, you’ll typically pay accrued interest in addition to the price; this affects the total cash required at settlement.

Key takeaways

• Yield basis quotes express bond prices as yields, enabling easier comparison across securities.
• Current yield = annual coupon ÷ purchase price; it indicates whether a bond trades at discount or premium relative to its coupon.
• Bank discount yield is used for discount instruments (like T‑bills) and is based on par value and a 360‑day convention.
• Verify whether quoted yields are net of broker markup and account for commissions and accrued interest when calculating total cost.