Bond Yields: Measuring the Returns on a Bond

Yield is an important measurement to understand when selecting bonds. And if you’ve ever shopped for bonds before, you’ve probably noticed that yield is measured in a few ways. Here are some of the most common ways.

COUPON RATE IS THE FIRST MEASUREMENT you may see when evaluating a bond. A bond’s coupon rate is the interest rate used to calculate the bond’s interest payments. You can generally determine how much interest a fixed-rate bond will pay each year by multiplying the bond’s face value (typically $1,000) by its coupon rate. For example, a bond with $1,000 face value and a 5% coupon rate will pay $50 interest each year until the bond matures.

That’s good information to have, but keep in mind that the bond’s price will fluctuate after the bond is issued and may differ from its face value. So unless you purchase a bond at its face value, you’ll also want to know its current yield. The current yield is the annual rate of return you can expect based on the bond’s current market price.

However, current yield does not consider a bond’s maturity. For that, you’ll need the bond’s yield to maturity, or YTM, which is an estimate of the annual rate of return you might expect if you hold the bond until maturity. It takes into account the interest you may earn and reinvest over the remaining years and any capital gain or loss if you purchased than bond at a price other than its face value. This particular measurement is especially helpful when comparing bonds with different maturities and coupon rates.

But what if your bond is callable, meaning that the bond issuer has the right to redeem it prior to maturity? With a callable bond, you’ll want to know that bond’s yield to call, or YTC, which is the rate of return you can expect if the bond is redeemed at its next call date.

It’s also helpful to know the lowest rate of return you may earn on a bond. Barring a default by the bond issuer. There’s a measurement for this called yield to worst, or YTW, and it is simply the lower of the bond’s yield to maturity or yield to call. If a bond is not callable, its yield to worst is typically the same as its yield to maturity.

Need some assistance sorting all of this out? Contact Copper Leaf Financial. With offices in Rutland and Williston, Vermont we develop a customized wealth management plan designed to integrate every aspect of your financial life. Call us today at 802.878.2731 to schedule a strategy session and begin building your road map to financial success.

Article published in November 2019 edition of Eye on Money. If you would like to be added to our mail list please email jennifer@dh-cpa.com.