|
Yield is a critical concept in bond investing,
because it is the tool you use to measure the return of one bond against
another. It enables you to make informed decisions about which bond to buy.
In essence, yield is the rate of return on your bond investment. However, it
is not fixed, like a bond?s stated interest rate. It changes to reflect the
price movements in a bond caused by fluctuating interest rates.
Here is an example of how yield works: You buy a bond, hold it for a year
while interest rates are rising and then sell it. You receive a lower price
for the bond than you paid for it because, as indicated above under
?Understanding Interest-Rate Risk,? no one would otherwise accept your
bond?s now lower-than-market interest rate. Although the buyer will receive
the same dollar amount of interest you did and will have the same amount of
principal returned at maturity, the buyer?s yield, or rate of return, will
be higher than yours was because the buyer paid less for the bond.
There are numerous ways of measuring yield, but two are of greatest importance to most investors
namely current yield and yield
to maturity
Current Yield
The current yield is the annual return on the dollar amount paid for a bond,
regardless of its maturity. If you buy a bond at par, the current yield
equals its stated interest rate. Thus, the current yield on a par-value bond
paying 6% is 6%. However, if the market price of the bond is more or less
than par, the current yield will be different. For example, if you buy a
$1,000 bond with a 6% stated interest rate after prevailing interest rates
have risen above that level, you would pay less than par. Assume your price
is $900. The current yield would be 6.67% ($1,000 x .06/$900).
Yield to Maturity
A more meaningful figure is the yield to maturity, because it tells you the
total return you will receive if you hold a bond until maturity. It also
enables you to compare bonds with different maturities and coupons. Yield to
maturity includes all your interest plus any capital gain you will realize
(if you purchase the bond below par) or minus any capital loss you will
suffer (if you purchase the bond above par). Ask your Financial Consultant
to provide you with the precise yield to maturity of any bond you are
considering. Don?t buy on the basis of the current yield alone, because it
may not represent the bond?s real value to you.
Yield to Call
The yield to call tells you the total return you will receive if you were to
buy and hold the security until the call date. As an investor, you should be
aware that this yield is valid only if the bond is called prior to maturity.
The calculation of yield to call is based on the coupon rate, the length of
time to the call date, and the market price of the bond.
|
 |