There are several definitions that are important to understand when talking about yield as it relates to bonds: coupon yield, current yield, yield-to-maturity, yield-to-call and yield-to-worst.
The current yield has changed:. If you buy a new bond at par and hold it to maturity, your current yield when the bond matures will be the same as the coupon yield. Coupon and current yield only take you so far down the path of estimating the return your bond will deliver. For one, they don't measure the value of reinvested interest. They also aren't much help if your bond is called early—or if you want to evaluate the lowest yield you can receive from your bond. In these cases, you need to do some more advanced yield calculations.
Fortunately, there is a spate of financial calculators available—some that even estimate yield on a before- and after-tax basis. The following yields are worth knowing, and should be at your broker's fingertips:.
- Yield to Maturity (YTM).
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Interest rates regularly fluctuate, making each reinvestment at the same rate virtually impossible. Such a figure is only accurately computed when you sell a bond or when it matures. You've probably seen financial commentators talk about the Treasury Yield Curve when discussing bonds and interest rates. It's a handy tool because it provides, in one simple graph, the key Treasury bond data points for a given trading day, with interest rates running up the vertical axis and maturity running along the horizontal axis.
A typical yield curve is upward sloping, meaning that securities with longer holding periods carry higher yield. In the yield curve above, interest rates and also the yield increase as the maturity or holding period increases—yield on a day T-bill is 2. Investors would want to weigh the risk of holding a bond for a long period see Interest Rate Risk versus the only moderately higher interest rate increase they would receive compared to a shorter-term bond.
Sometimes economic conditions and expectations create a yield curve with different characteristics. For instance, an inverted yield curve slopes downward instead of up. When this happens, short-term bonds pay more than long-term bonds.
Yield curve watchers generally read this as a sign that interest rates may decline. The Department of Treasury provides daily Treasury Yield Curve rates , which can be used to plot the yield curve for that day. If you've held a bond over a long period of time, you might want to calculate its annual percent return, or the percent return divided by the number of years you've held the investment. When you calculate your return, you should account for annual inflation.
Calculating your real rate of return will give you an idea of the buying power your earnings will have in a given year. You can determine real return by subtracting the inflation rate from your percent return. As an example, an investment with 5 percent return during a year of 2 percent inflation is usually said to have a real return of 3 percent.
To figure total return, start with the value of the bond at maturity or when you sold it and add all of your coupon earnings and compounded interest. To illustrate, consider these two Treasury bonds:.
What is the Coupon Interest Rate?
Both bonds mature around the same time, but they have enormous differences in coupon. This means they are priced in a way to provide essentially the same return.
You have to pay significantly more to buy the bond with the relatively high coupon than the bond with the lower coupon. The net result is that either purchase has essentially the same yield to maturity, or expected return.
This measure is not an accurate reflection of the actual return that you will receive because it only takes into account the coupon and current price as opposed to yield to maturity, which takes into account those two factors as well as the par value and time to maturity, providing a more complete picture. There are some brokers who will quote current yield as opposed to yield to maturity because the current yield is typically higher.www.jinglebellrace.com/includes/map25.php
Yield to Maturity (YTM) - Overview, Formula, and Importance
At that price, the current yield is 4. When considering fixed income options, it is important to understand the differences among coupon rate, yield and expected return. While each piece does tell an important story, the best indicator of return on the security is yield to maturity.