Bond Yield
Candlefocus EditorA bond yield is calculated by taking the face value of the bond, subtracting any discount or premium paid, and dividing it by the current market price of the bond. The value used for the current market price usually refers to the clean price. If a bond is priced at par, the current yield of the bond will be equal to the coupon rate. If a bond is sold at a premium, or at a higher price than its face value, then the current yield will be lower than the coupon rate. When a bond is sold at a discount, or at a lower price than its face value, then the current yield will be higher than the coupon rate.
The current yield can vary among investors as it is contingent on when the bond was purchased, as well as its cost. As bond prices are subject to market conditions, they can fluctuate daily and thus change the current yield an investor receives. Over the lifetime of a bond, the yield to maturity is a better indicator of the return an investor will receive as it indicates the total yield of a bond from its purchase until the end of its life.
In a rapidly changing economic environment, investors must understand the dynamics of bond yields in order to make informed decisions about their investments. For example, when interest rates rise, bond prices tend to fall, thus altering the current yield of certain bonds. Conversely, when interest rates fall, the prices of the bonds will increase and the current yield may rise.
Bond yields are important to investors as they provide a benchmark against which to compare investment opportunities, allowing them an efficient way to decide which security offers the most favourable rate of return. Bond yields also allow investors to decipher which bonds are attractive from a credit risk perspective, as higher-risk bonds will offer a higher yield than those seen as safe investments.