Calculating a Bond Yields
This calculator can be used to find both a bond’s current yield and its yield to maturity. The calculator needs a total of four inputs, including:
- The current price of the bond, which is the bond’s market price
- The par value of the bond, also known as its nominal or face value
- The bond’s coupon rate, also known as its nominal yield
- The number of years until the bond matures
The calculator then provides the user with two outputs:
- The current yield of the bond
- The bond’s yield to maturity
Why are bond yields so important to understand?
Before an investor buys a bond, they need to have a thorough understanding of the bond’s time to maturity, yield, and risk of nonpayment. They should also know if the bond carries with it certain features such as convertibility. This calculator can help the investor quantify two important rates of return they can expect from the bond: its current yield and its yield to maturity.
Figuring out a bond’s current yield
When a bond is issued, it will have a coupon rate that tells the investor how much money they can expect to receive from the bond each year. For example, if a bond’s par value is 1,000 and its coupon rate is 5.000%, the investor can expect to receive 1,000 x 0.05, or 50 each year. While this payment is fixed, the price of the bond on the secondary market can deviate from 1,000. A bond’s current yield is a function of the coupon rate and its current price as shown below:
Current Yield = (Par Value / Current Value) x Coupon Rate
A bond selling for 950, with a par value of 1,000 and coupon rate of 5.000% would have a current yield of (1,000 / 950) x 0.05 or 5.263%. Intuitively, this makes sense. Another way to get to this same result would be to take the money received each year from the bond – in this case 50 – and divide it by 950. Once again, we find the bond’s current yield is 5.263%.
Determining a bond’s yield to maturity
As mentioned, a bond’s current price can be different than the bond’s par value, which is the amount of money the investor receives when the bond matures. A bond that sells for 950 and carries a par value of 1,000 is selling at a discount to par value, while a bond that sells for 1,050 and carries a par value of 1,000 is selling at a premium to its par value. When a bond is purchased at a discount or premium, an investor can receive more or less money when the bond matures than they paid for it.
This is why it’s also important for investors to understand a bond’s yield to maturity, since this calculation takes into account this gain or loss on the bond when it matures. Here are two simple rules of thumb for these scenarios:
- A bond that is selling at a discount to par value will not only have a current yield that is greater than the bond’s coupon rate; the bond’s yield to maturity will higher than its current yield too.
- A bond that is selling at a premium to its par value will not only have a current yield that is less than the bond’s coupon rate; the bond’s yield to maturity will be less than its current yield too.