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Tuesday, 11 February 2014

Bond Yield

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Yield

Bonds are usually recognized by yields. Simply speaking, yield is the rate of return an investor receives on the maturity of his bond. For a bond, yield is a function of the coupon (or interest) payments which are fixed and the bond's purchase price. There exists an inverse relationship between the bond price and interest rates. Bond prices are correlated with their yields. As market interest rates decrease, bond price will increase on account of higher relative coupon rate the bond produces thus becoming more attractive to the investors.

Yield can be measured in two ways: Current Yield and Yield to Maturity. Current yield is simply the coupon interest received with respect to the current market price of the bond. Yield to maturity is a more acceptable measure of calculating the rate of return on a bond. It can be defined as the discount rate at which the present value of cash flows (in terms of coupon payments and the face value of the bond) equals to the current market price of the bond. When we talk about yield curve, our concern is yield to maturity and not current yield as the former is a better indicator of the rate of return on a bond.

 

 

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