Calculating Yield A bond's yield is what the bond pays you over the period of time that you hold it. If you buy a bond from the issuer, at a face value of $1,000 and an interest rate of 5 percent, and you hold it until maturity, here's how you calculate the yield: Yield = {(interest rate) x (par value)} / purchase price. In this case, {(.05) x (1,000)} / 1,000 = 0.05 or 5 percent.				> Home > Glossary > Support
		The fact that bonds can be bought and sold before maturity, at prices other than face value, adds an element of excitement to calculating yield. If you paid above par value for the bond, say $1,200, and the interest rate is 5 percent, your overall yield will be lower than 5 percent because you have to factor in the extra $200 you paid to buy the bond. Your yield would be {(.05) x (1,000)} / 1,200, or 4.16 percent.
		How Bonds Are Priced
		It may be helpful here to explain how bonds are priced. The face values of bonds are always round numbers, generally $1,000, $10,000 and $100,000. When bond traders talk about a bond's current price, they refer to the par value as 100. If a bond is trading at a premium (higher than face value) its price will be more than 100 -- say 102, if the premium is 2 percent. If you want to buy a $10,000 bond that is trading at 102, you will have to pay $10,200. (2 percent of 10,000 is 200).
		Now, here's a pop quiz: which way have interest rates moved to cause this bond to become more expensive? Right, interest rates went down and new bonds are paying less interest than this existing bond, making this bond more attractive.
		If a bond with a par value of $10,000 is trading at 98, what does that mean? It means that a person can buy the bond for $9,800 ($10,000 - $200). This would happen if interest rates have gone up, making new bonds with the higher rate more attractive.
		In either case, when the bond matures you will receive $10,000 in principal.
		Understanding Yield
		Bond traders have to think about several different kinds of yield. Here are some terms and definitions to help you understand yield.
		Par Value -- The face value of a bond (denominated in round numbers, generally multiples of $1,000).
		Premium Bond -- A bond whose value on the open market is higher than par value.
		Discount Bond -- A bond whose value on the open market is less than par value.
		Yield -- A bond's interest divided by the price you paid for it. This is the measure of the income you get from a bond. (This takes into account whether you paid a premium or discount on the bond, if you bought it on the open market.)
		Current Yield -- The bond's interest rate (coupon rate) divided by its current market price. A $1,000 bond (par, or face, value) at 7 percent that is selling at $1,200 has a current yield of 70/1200 or 5.8 percent. Since you are paying over face value, your percentage return is less than 7 percent.
		Yield to Maturity -- The rate of return you can expect to get from your bond if you hold it until the maturity date.
		Yield to Call -- The rate of return you will get if the bond is called (the issuer buys it back from you before the maturity date) at the earliest permitted date. Not all bonds are callable.
		Yield to Put -- The rate of return you will get if you sell the bond back to the issuer before the maturity date.
		Zero Coupon Bond -- A bond that is sold at a deep discount (i.e. cheap) because it doesn't pay periodic interest payments. Instead, its value increases gradually until at maturity it is worth par value. For example, you might pay $3,000 for a 25-year zero-coupon bond with a face value of $10,000. Even though this bond does not pay income, it will accrue value each year until at maturity it will be worth $10,000. In other words, you earn $7,000. "Zeros" are generally a good investment for someone who knows he or she will need a certain amount of money at a certain time. They are extremely risky, however, if you have to sell them before maturity on the open market, because they are highly reactive to interest rate changes -- if the interest rate rises, the value of your zero coupon bond will drop.
		Tax-deferred account note: The accrued value each year on a zero coupon bond is normally taxable, even though it is not "paid" to you until the maturity date. That's why this type of investment may be suitable for tax-deferred accounts.
		Grading Bonds: Unbelievably High Yield May Mean Junk
		With bonds, incredibly high yields usually mean incredibly low credit-worthiness. If you are looking for a reliable investment, stick to high-grade bonds, not "high-yield," even though they may not give you higher-than-average yields. After all, if the bond issuer defaults you won't get any yield, let alone your principal.
		Several companies rate bonds -- two of the best known are Moody's and Standard & Poor's. In general, bonds are rated with letter grades, with AAA and AA being the best. A and BBB are "general" quality, and junk (high-yield) bonds are generally BB and lower.
		Why would someone invest in junk bonds? An experienced investor who is willing to take on high risk for the possibility of gaining high returns might invest in high-yield bonds as part of an overall balanced portfolio. Such an investor would likely research the different issuers of high-yield bonds to find out why they have been given a low credit rating. The credit rating is based on the company's perceived ability to pay interest on the loan, and pay back the principal amount on time. An investor could be expected to choose a company that was recovering from an atypical bad spell over a company that had a history of shoddy management and cash flow problems.

		Previous		Next

	© 2025 Morningstar Investment Management LLC