Bond Yield
What is bond yield?
Bond yield is the return an investor realizes from holding a bond. It reflects the interest payments (coupon) received and, depending on the measure, any gain or loss if the bond is purchased at a price different from face value. Yields change as a bond’s market price and prevailing interest rates change.
Key concepts
- Coupon rate: The bond’s stated annual interest relative to its face (par) value.
- Current yield: Annual coupon divided by the bond’s current market price.
- Yield to maturity (YTM): The internal rate of return that equates the present value of all future bond cash flows (coupons and principal) to the bond’s current price.
- Bond equivalent yield (BEY): Annualized measure that adjusts semi-annual coupon yields to an annual basis.
- Effective annual yield (EAY): Annual yield that accounts for compounding within the year.
- Price-yield relationship: Bond prices and yields move inversely—when market interest rates rise, existing bond prices fall, and vice versa.
- Accrued interest, clean price, and dirty price: Prices quoted may exclude (clean) or include (dirty) interest accrued since the last coupon.
Basic formulas and examples
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Coupon rate = Annual coupon payment / Face value
Example: $100 annual coupon on $1,000 face value → Coupon rate = $100 / $1,000 = 10%. -
Current yield = Annual coupon payment / Bond price
If that $1,000-face bond trades at $1,100, current yield = $100 / $1,100 ≈ 9.09%. -
Approximate YTM (rule-of-thumb) = [C + (FV − PV) / t] / [(FV + PV) / 2]
Where C = annual coupon, FV = face value, PV = current price, t = years to maturity.
(This is an approximation; exact YTM is solved by finding the discount rate that sets the PV of cash flows equal to PV.) -
BEY (for semi-annual coupons) = 2 × semi-annual YTM
Example: semi-annual YTM = 5.979% → BEY ≈ 11.958%. -
EAY = (1 + i/n)^n − 1
Where i = nominal annual rate (decimal), n = compounding periods per year.
Example: semi-annual nominal rate 11.958% → EAY ≈ (1 + 0.11958/2)^2 − 1 ≈ 12.32%.
Price and yield: an illustrated point
A bond with a $1,000 face, 5 years to maturity, and a $100 annual coupon pays 10% in coupons. If comparable market rates rise to 12%, buyers will demand a yield of 12% on similar securities. The existing bond’s price must fall so that its fixed $100 coupons and $1,000 maturity payment produce a 12% return for a new buyer. If rates fall below 10%, the bond’s price will rise because its coupon becomes relatively attractive.
Additional considerations
- Time value of money and payment frequency matter. Simple coupon and current-yield measures omit reinvestment and timing effects; YTM and EAY account for them.
- Fractional periods and accrued interest complicate yield calculations when a bond is sold between coupon dates. The clean price excludes accrued interest; the dirty price includes it.
- Bond ratings (credit quality) affect yield: higher-rated bonds (e.g., AAA) typically have lower yields; lower-rated or “high-yield”/“junk” bonds offer higher yields to compensate for greater default risk.
- Yield curve and yield spreads: the yield curve plots yields by maturity for bonds of similar credit quality. Yield spreads (differences between yields of two securities) indicate relative risk, liquidity, or other market factors and are often expressed in basis points.
Common questions
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What does a bond’s yield tell investors?
It quantifies expected return from coupon payments and any capital gain or loss if held to maturity (depending on measure). Higher yields often signal higher perceived risk. -
Are high-yield bonds better than low-yield bonds?
Not inherently. High-yield (junk) bonds offer higher income but come with greater default and credit risk. Choice depends on an investor’s goals and risk tolerance. -
Are high-yield bonds the same as junk bonds?
Yes—“high-yield” is the neutral term; “junk” is pejorative but refers to the same lower-rated credit instruments. -
How do investors use yields?
Investors compare yields across maturities, issuers, and credit qualities to assess value, build strategies (e.g., curve trades), and infer economic expectations from the yield curve slope.
Bottom line
Bond yield is the measure of return an investor receives from a bond. Simple measures (coupon rate, current yield) are easy to calculate but incomplete. More comprehensive measures (YTM, BEY, EAY) account for price, timing, compounding, and maturity and are essential for comparing bonds and making informed investment decisions. Consider credit ratings, accrued interest conventions, and market interest-rate movements when evaluating yields.