Bond yield is the return an investor can expect from a bond issue within a given period, calculated using current data. A simple formula divides the annual coupon by the bond price. Understanding bond yields is important for investors to determine whether to buy and hold a bond issue.
Bond yield is essentially the amount or percentage of return an investor can expect to receive from a bond issue within a given period of time. It is important to note that calculating this involves using current data relating to the current price of the bond rather than the price at the time of purchase. Determining the current state of the bond yield also requires understanding the current annual coupon associated with the bond. The calculation also assumes that the buyer remains on the bond for at least a one-year period.
A simple formula for calculating a bond yield involves dividing the annual coupon by the bond price. For example, if the bond had a price of $100.00 US Dollars (USD) with an annual coupon of $6.00 USD, the yield on the bond would be projected to be six percent. However, this yield assumes that there will be no change in price and that the buyer will remain on the bond for at least one year.
If there is a change in interest rates that leads to a shift in the current price of the bond, the yield on the bond may indicate a loss of principal. Using the same example, if the bond price fell to $90.00 USD, this would result in a loss of $10.00 USD, which is partially offset by the $6.00 USD coupon. However, there remains a capital loss of $4.00 USD for the annual period. Similarly, an upward movement in the bond’s price would increase the realized capital gains from the investment.
Understanding how bond yields work is important for investors. By evaluating factors that may affect the future value of the bond issue, investors can determine whether it is in their best interest to buy the bond issue and hold it for at least one year. If projections indicate that the bond is highly likely to produce a decent return over a year or two, the investor may choose to buy the issue. However, if there are indications that the bond will drop in value over the first year, that means the investor probably wouldn’t be able to sell the bond enough to break even, much less make a profit on the investment. In such a situation, the investor is advised to look into other bonds or to choose entirely different investment opportunities.
Protect your devices with Threat Protection by NordVPN
