Bond yield refers to the return an investor earns on a bond investment. It represents the annualized return on the bond's current market price and is typically expressed as a percentage. Bond yield is a crucial metric for investors because it indicates the income generated from holding a bond.
Types of Bond Yields:
1. Coupon Yield (Nominal Yield):
Coupon yield is the annual interest rate paid by the bond issuer as a percentage of the bond's face value (par value).
Calculation:
Coupon Yield = Coupon Payment÷ Face Value * 100
Where:
Coupon Payment: Annual interest payment received by the bondholder.
Face Value: Par value or nominal value of the bond.
*Example:
If a bond has a face value of ₹1,000 and pays an annual coupon of ₹80, the coupon yield would be 80÷ 1,000 * 100 = 8%
2. Current Yield:
Current yield measures the bond's annual coupon payment relative to its current market price.
Calculation:
Current Yield= Annual Coupon Payment ÷ Current Market Price * 100
Where:
Annual Coupon Payment: Annual interest payment received by the bondholder.
Current Market Price: Market price at which the bond is currently trading.
Example:
If a bond with a face value of ₹1,000 pays an annual coupon of ₹80 and is trading at ₹950, the current yield would be 80÷ 950*100 = approx 8.42%
3. Yield to Maturity (YTM):
YTM represents the total return anticipated on a bond if held until maturity, considering both coupon payments and any capital gain or loss due to the difference between the purchase price and face value.
Calculation:
YTM is calculated using an iterative process because it considers the present value of all future cash flows (coupons and principal repayment) discounted at the bond's yield.
Example: If a bond is purchased at a premium (above face value) or discount (below face value), YTM will differ from the coupon rate.
Importance of Bond Yields:
Income Generation: Bond yields indicate the income an investor can expect from holding the bond.
Comparison Tool: Investors use yields to compare different bonds and assess their relative attractiveness.
Risk Assessment: Higher yields often indicate higher risk associated with the bond issuer's credit quality or market conditions.
Valuation: Yields influence bond prices; as yields rise, bond prices fall, and vice versa, due to the inverse relationship between bond prices and yields.
Considerations:
Yield Fluctuations: Bond yields can fluctuate based on changes in interest rates, credit ratings, and market demand.
Yield Spread: The difference in yields between different bonds (e.g., corporate bonds vs. government bonds) reflects risk perceptions and market conditions.
Tax Implications: Taxable vs. tax-exempt bond yields can vary significantly depending on investor tax brackets and bond characteristics.
In summary, bond yield is a critical metric for bond investors as it provides insights into the income potential and valuation of bond investments. Understanding different types of bond yields helps investors make informed decisions based on their investment objectives, risk tolerance, and market conditions.