Bond Yield

Current yield: The ratio of the annual interest payment to the bond’s current price.

Calculating Yield to Maturity

Investors usually consider yield to maturity (YTM) to gauge the profitability of a bond. The steps to calculate the YTM of a bond with a face value of $1,000 and a 7% coupon rate are:

• Find the amount of annual interest offered by the bond. In the above example, the bond will yield an annual interest of $70.
• If the purchase price of the bond is lower than the par value, the profit on the price would be the difference between the par value and the purchase price. Thus, if you have bought the bond at $940 and hold it till maturity, you would realize a minimum profit of $60.
• To calculate the bond yield, consider that the coupon rate is compounded annually and you are reinvesting the interest into the bond.
• Consider the maturity period of the bond and the purchase price to calculate the compound interest on the bond for this period. If the bond is maturing in five years, the compound interest on the bond would be $378.40.
• Thus, the total return on your investment in the bond is $378.40 + $60 = $438.40.
• Derive the percentage returns on your investment. For this, multiply the total return on investment with 100 and divide by the purchase price of the bond. Thus, the bond is generating 46.63% ROI ($438.40 * 100 / 940 = 46.63%).
• Calculate the yield to maturity for this bond by dividing the percentage returns on your investment by the maturity period. Thus, 46.63 / 5 = 9.33% is the yield to maturity.

Investors can also calculate the current yield with the following formula:

Current Yield = [(Coupon Rate ÷ Bond Price) x Par Value] + [(Par Value – Bond Price) ÷ YTM]