What is Bond Yield?

Bonds are one of the safest investment options on the financial market. Bonds are a good option for investors who are cautious about taking on risk. However, many investors are aggressive and seek to diversify their portfolios and reduce the risk. It doesn't matter what risk level you have, it is a good idea understand the basics of bonds.

It's a good idea to learn about the bond yield while you are at it. When researching potential bonds to invest in, many investors are confused about what the bond yield means. This guide will help you to understand the meaning of bond yield.

Let's get started.

What's bond yield ?

Bond yield simply refers to the return that an investor receives from a bond. The coupon rate is the basic definition of the bond yield. The coupon rate is the interest rate paid on bonds. The coupon rate is the simplest type of bond yield because the interest payments are basically the returns from bonds.

Now that you understand the meaning of bond yield, it is time to go beyond the definition to get to know this concept better.

Better Understanding bond yield

Although it may seem simple to calculate the bond yield and the coupon rate, it is not. Because of metrics such as compound interest payments and the time value money, the bond yield is more complex. This allows for more complicated calculations such as the yield to maturity or the bond equivalent yield. Let's look at these two metrics.

Yield to maturity

The yield to maturity of a bond is the return an investor can expect from a bond, if it is held until maturity. The investor does not trade the bond on the secondary market. They hold the bond until its maturity date. The yield to maturity of a bond is calculated by taking into account future cash flows, including interest payments, as well as the maturity value. The YTM rate is the rate at which future cash flows equal the current price of the bond.

Bond equivalent yield

Many bonds pay interest twice per year. Some bond payments are semi-annually or half-yearly. For such bonds, the bond equivalent yield is relevant. If you are looking for the bond equivalent yield, the following formula may be helpful.

Let's take an example to illustrate this. An investor might buy a bond of Rs. 1,000 face value. 1000 for Rs. 900 Let's say the maturity date is 6 months, or 183 days. Here's how to calculate the BEY.

BEY = [(1,000-900) / 9000] x (365/183)

This is approximately 22%.

The link between the bond yield and the bond price

Both conceptually and mathematically, the bond yield is in an inverse relationship with the bond price. The yield decreases when the bond price goes up. The reverse is true. If you are looking to invest in bonds, you will typically look for bonds that have low prices and higher yields. If you are looking to sell a bond, however, you might wait until the bond's price is higher so that you can cash in on greater returns. If you intend to keep the bond until maturity, you might prefer higher bond yields so that your overall returns are higher.

Conclusion

It is important to be able to comprehend the various ways that bond yields are calculated as an investor. You will be able to make an informed decision on which bond you should invest in and when. This gives you an idea of when your bond will be sold, in the event that you don't plan on keeping it until maturity. The concept of bond yield is a key component in making smarter investment decisions.