Understanding bond yields is important for choosing the best investment. High-yield bonds offer higher returns, but calculating the yield involves considering the bond’s price, face value, and interest payment. Yield to Maturity (YTM) requires a calculator, but it shows how much you’ll earn if you hold the bond until maturity. Buying a bond at a discount yields more in the long run, while buying at a premium yields less. Buying at face value falls in the middle.
The yield on a bond is the amount of return on your investment or the amount of interest earned on a bond in which you invest your money. High-yield bonds yield a higher return on investment than those with lower interest rates or yields. Part of choosing the best bond yield is calculating the bond yield, which considers the price paid to purchase the bond, the face value of the bond, and the interest payment on the bond.
To calculate a bond’s yield, divide the bond’s face value or coupon rate by the price you pay to purchase the bond. For example, a bond issued at a face value of $1,000 United States Dollars (USD) that has a coupon rate of 10% produces $100 USD in interest. When the same bond, with a face value of $1,000 USD, is sold at a discount rate of $800 USD, then the bond’s yield increases to 12.5%.
Adversely, a $1,000 USD face value bond selling at a $1,200 USD premium pushes the bond’s yield to 8.33%. Therefore, an important part of choosing the best bond yield is evaluating whether you are paying face value, a discount, or a premium price to purchase the bond in the first place.
The second main calculation is to calculate Yield to Maturity (YTM). Unfortunately, this calculation is not a simple equation. Calculating this figure requires you to use a bond yield-to-maturity calculator, which you can find online, or use a financial calculator to input the figures. However, the answer to this calculation tells you how much money you will earn from your investment in the bond if you hold it until the bond’s maturity date.
In short, if you understand how bonds behave, you can choose the best bond yield. Essentially, as bond prices go up, the bond yield goes down. When bond prices go down, then bond yields go up. This means that if you have the opportunity to buy a bond at a discount price, it will yield more in the long run than paying a premium or par value.
If you buy the bond at a higher price, you will earn less yield than if you buy it at face value or at a discount. If you buy the bond at face value, then you fall in the middle, not earning as much as buying the bond at a discount, but earning more than buying the bond at a premium.
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