Bonds are among the many safe investments options available in the financial market. Mainly, investors with a risk profile that’s major risk-averse consider investing in bonds. Many risk-aggressive investors shop in the bond market in an attempt to diversify their investments portfolio and balance the risk therein. Many investors often are doubtful about the bond yield meaning when they’re reading up on possible bonds to invest in. So now let us all know what exactly bond yield is.
1. What is a Bond Yield?
Bond yield is simply the returns that an investor obtains from a bond. In its most basic form, the bond yield would be equal to the coupon rate. You’ll perhaps recall that the coupon rate is the rate at which interest is paid out on a bond. Since the interest payments earned are essentially the returns obtained from a bond, the coupon rate is the simplest kind of bond yield.
2. What is the concept of Bond Yield?
Equating the bond yield with the coupon rate may be easy to understand, but in truth, it’s not that simple. The bond yield is a more layered concept because metrics like the time value of money and compounding interest payments all come into the picture. This makes it easy for more complex calculations like the yield to maturity and the bond equivalent yield.
3. What is Yield to maturity (YTM)?
The yield to maturity for a bond is the total return that an investor can expect from a bond if that bond is held until maturity. This signifies that the investor does not trade the bond in the secondary market. It holds the bond till maturity date which makes yield to maturity for a bond takes into account all future cash flows expected till maturity, such as the interest payments as well as the value at maturity. Yield to maturity is that rate at which the present value of such future cash flows equals the prevailing price of the bond.
4. What is Bond Equivalent Yield (BEY)?
This becomes relevant for bonds that pay out interest twice a year, on a semi-annual or half-yearly basis.
Bond Equivalent Yield =[{Face Value – Purchase Price} / Price of the Bond] X (365 / Number of Days Till Maturity)
The formula above can be helpful to calculate the bond equivalent yield. To understand easily, we will give you one example. If an investor buys a bond with a face value of Rs 1000 for Rs 900 and the number of days till maturity is six months or 183 days. So, BEY = [(1000-900)/900] X (365 /183) = 22%. So the bond equivalent comes up to 22%.
5. Relation between Bond Yield and Bond Price
the bond yield and bond price share an inverse relationship. When the price of a bond rises, the yield reduces and vice-versa. If you’re looking to sell a bond instead, you may likely wait for an opportunity where the price of the bond is high, so you can cash out with greater gains. But if you plan to hold the bond till maturity, you may perhaps with for greater bond yields, so mainly returns remain on the higher side.
