What Are Bond Yields?
The bond yield measures the annual return on the certificate (the rate of interest), which is expressed as a percentage of the current market price of the bond. This is an important investment measure , since a bond often ties up an investor’s cash for long periods of time.
The bond yield is also important for those individuals or organizations who wish to issue bonds, since it provides a market indication of the cost of raising capital in this way.
How Do You Calculate Bond Yield Value?
The bond yield is defined as follows:
Bond Yield = (Annual Return on the Bond Certificate) / (Market Value of Bond) x 100
Investors quote the bond yield as a percentage. It represents the percentage return that the investor will receive.
What Makes the Best Bond Yield Ratio?
To the investor the best bond yield ratio is simply the highest positive percentage. A high bond yield is however bad news for the bond issuers since this implies the cost of capital is higher.
Other Useful Background on Bonds
The market usually offers bonds for sale in multiples of a thousand. For example a new 20 year $1,000 bond which pays interest at 5% produces an annual yield amount $50. This is often paid as $25 every six months.
Key Issues When Assessing Market and Historic Bond Yield Ratios
Two key problems with the bond yield are frequently considered to be:
- The ratio can be complicated by the time value of money. In other words a $1 today is worth more than a $1 in 30 years (think of the phrase “a bird in the hand is worth two in the bush”).
- Changing the market interest rates have a significant impact on bond trading and eventually in yields. The interest rate changes in the market do not impact those bonds that have already been issued, but do affect the annual return that needs to be quoted on newly issued bonds.
Other Bond Yield Issues
The investor needs to be aware of the following issues when considering bonds (as always professional independent advice should also be sought before making any investment decisions):
- Zero Coupon Bonds – these pay no interest, but are sold at an initial big discount
- Different Types of Bonds – some, but not all bonds are backed by assets
- Interest Rates – generally bond values fall when interest rates rise (and vice versa)
- Yield to Call – simplistically some bonds give the issuer the right to recall or redeem the bond.