Rate of Interest vs Yield

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Suppose you invest Rs 1,000 in the initial offer of a tax free bond that pays an annual rate of interest of 10%, that is a payment of Rs 100 every year. The bond is listed on the bourses and is traded regularly.

 

Now after a year, the same bond is traded at Rs 1,100. Now a person who buys that bond at Rs 1,100 will also get Rs 100 when interest is paid every year. But for the new buyer, the payment he/ she receives is calculated as (Rs 100/Rs 1,100)x100 = 9.09%. So although the bonds are paying an annual rate of interest at 10% to both the bond holders, that is you and the new investor, your yield as well as interest income is 10%, while for the new buyer although the stated rate of interest is 10%, the yield works out to be just 9.09%. This, however, can change depending on the time when he/she buys the bond and the time of annual payment of interest on those.

 

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