What is Bond Yield?

Introduction

Investors prefer having at least one debt-based investment to give their portfolio a hedge against equity market fluctuations. One such investment option, bonds, is considered a relatively safe form of investment. Investors who are slightly risk-averse and are satisfied by getting lower returns usually prefer bonds to those who prefer high returns with unknown risk.

The bond market is a good investment option for beginners. You could opt for investing in bonds at a young age to reap their benefits as you grow old. Though there are many types of bonds in the market, it is integral to understand what bond yield is in-depth so you can make a more informed investment. Bond Yield is one of the deciding factors for investors to choose a bond to invest in. Here’s what you need to know about a bond yield.

What is a bond yield?

Bond yield means the expected returns over a tenure and any fixed income that an investor would get upon investing in specific bonds. Bond yield takes all the future cash flows into consideration and gives the rate of return from the financial instrument. They are expressed as a percentage depending upon the amount of investment in the market. The tenure of these bond yields can be calculated periodically (monthly, quarterly or annually).

How is a bond yield calculated?

Bond yield is calculated based on the coupon payment. The coupon payment is the interest paid against the bond.

Typically, bond yield can be calculated by dividing the coupon payment by the bond’s purchase price. However, there are different bond yields.

Generally, if a bond was purchased for Rs. 10,000 and you receive Rs. 1,000 as the annual coupon payment, the bond yield will be Rs. 1,000/Rs. 10,000 = 0.1 which, in percentage terms is 10% annual rate.

The most common calculation of a bond yield is the coupon payment divided by the face value of the bond.

Therefore, Coupon Rate = Annual Interest Payment / Bond Face Value.

The bond’s coupon rate is the rate of interest that the bond carries on the face value, not the market value. However, if the bond trades at a premium or discount, the bond yield rate will differ from the coupon rate because the bond yield is calculated on the purchase value.

If the annual coupon payment is divided by the bond’s current market price, the investor can calculate the bond’s current yield. The current yield is simply the current return you would expect if you hold that investment for one year. You can calculate the current yield manually or using online calculators. 

Therefore, Current Yield = Annual Interest Payment / Bond Market Price.

However, a bond yield takes into consideration the actual cash flows of the bond, and it could be quite complex to arrive at the actual returns. The interest could also change frequently, which impacts the yield. Therefore the above calculations may not give you accurate results.

Bond Yield Calculators

To help investors easily calculate the bond yield, IndiaBonds has developed a highly accurate bond yield calculator that considers the coupon interest, payment dates, government holiday calendar for interest adjustments and many more factors that affect the bond yield. Unlike generic calculators, IndiaBonds is India’s first customised calculator, which gives the yield for a particular bond.

For investors, having an online tool like a bond calculator can help them assess their returns on the go without relying on financial experts to do the complex calculations for them. IndiaBonds bond yield calculator is accessible to anyone who signs up and provides a range of bond calculations precise to the fourth decimal point.

What are the different types of bond yields?

Now that you know two types of bond yields, as explained above, the current yield and the coupon yield, here are the other different types of yields in bonds that investors use.

1. Yield to Maturity

Yield to Maturity is the rate of return if the investor purchases the bond at market value and holds it till its maturity. It factors in all the capital gains or losses and coupon payments. However, yield to maturity is calculated assuming the coupon payments are reinvested and not withdrawn. This is an effective comparison tool between two bonds used by investors to make an informed decision.

2. Effective Annual Yield

For bonds that offer coupon payments semi-annually, the Effective Annual Yield can be calculated as ((1+(YTM/2))^2)-1. This will factor in the compounding effect of semi-annual payments.

3. Nominal Yields

Sometimes, the bonds may carry a floating rate of interest which changes based on several pre-defined factors. Index bonds are linked to an underlying index, and coupon payments will fluctuate based on the performance of the index. Other nominal yields include fixed bond rates that do not change over the bond’s tenure. Each type carries its own risk, and the returns vary accordingly.

What do bond yields tell investors?

Investors determine whether the bond is a good investment or not by using the different yields of bonds. It gives them insight into the frequency of returns and the rate of return they can expect from their investment. Investors can also use the yields to compare different bonds to each other and pick one that suits their needs. In order to compare two bond yields, it is recommended to ensure that the interest rate reflects the same time period and frequency of coupon payments or use the yield to maturity rate.

Conclusion

Bonds can be purchased directly from bond issuers or the bond market. However, bond yields are not the only determining factor when choosing the right investment. Each bond carries some level of risk, and the investor must conduct their due diligence and assess the elements of the bond before investing. Use the IndiaBonds calculator to validate your returns and make an informed investment.

Disclaimer: Investments in debt securities/ municipal debt securities/ securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully.