Bond yield

What bond yield means

Bond yield is the return an investor earns from holding a bond, expressed as an annual percentage of what the bond currently costs. It is not the same as the coupon. The coupon is the fixed interest payment set when the bond was issued, quoted against the face value. The yield takes the current market price into account, so it keeps changing as the price changes.

The key relationship is inverse. When a bond's price rises, its fixed payments represent a smaller return on the new, higher cost, so the yield falls. When its price falls, the same payments represent a bigger return, so the yield rises. Price and yield are two ways of describing the same thing.

Yields are watched by almost every part of the financial world. Government bond yields are used as benchmarks for borrowing costs, the benchmark low-risk rate in valuation models, and a barometer of expectations about growth, inflation and central bank policy. Currency traders follow yield differences between countries, and equity investors compare dividend yields with bond yields.

How it works

There are several yield measures, and it helps to know which one you are looking at.

• Coupon rate. Annual coupon divided by face value. It is fixed.
• Current yield. Annual coupon divided by the current market price. It ignores gains or losses at maturity.
• Yield to maturity, often shortened to YTM. The single annual rate that makes the present value of all remaining payments equal to the current price. It assumes the bond is held to maturity, the issuer pays in full, and coupons are reinvested at the same rate. Quoted yields are usually YTM.
• Yield to call. Used for callable bonds, it assumes early redemption on the first call date.
• Real yield. Nominal yield minus expected or actual inflation, which shows the return in purchasing-power terms.

Exact YTM needs a trial-and-error or spreadsheet solution, but a quick approximation is available. Approximate YTM equals the annual coupon plus the annual share of the discount or premium, divided by the average of face value and price.

A worked example

These numbers are illustrative. A bond has a face value of 1,000, a 3 percent coupon and 4 years left to maturity. The coupon is 1,000 × 3% = 30 a year. Its market price is 920.

• Current yield = 30 ÷ 920 = 3.26 percent.
• The discount to face value is 1,000 − 920 = 80. Spread over 4 years, that is 20 a year.
• Approximate YTM = (30 + 20) ÷ ((1,000 + 920) ÷ 2) = 50 ÷ 960 = 5.21 percent.

If the price rose to 1,000, the bond would sell at par and the yield would equal the coupon, 3 percent. If the price rose to 1,050, the bond would have a premium of 50, so the yield falls below 3 percent. The coupon never changed in these cases. Only the price and the implied return did.

A comparison helps. If the investor can instead buy a new 4-year government bond yielding 4 percent, the 5.21 percent bond offers extra yield. That extra amount is a payment for taking more risk, for example credit risk, or for lower liquidity.

Why it matters

Yields affect almost everything priced against interest rates. Mortgage rates, corporate borrowing costs and the discount rates behind share valuations all tend to move with government bond yields. A sharp rise in yields can pressure growth shares, lift a currency whose yields are rising relative to others, and push down prices of existing bonds and bond funds.

The shape of yields across maturities, called the yield curve, contains information too. Comparing short and long yields is a common way to gauge expectations about economic growth and policy rates. Yield spreads, meaning the difference between a corporate bond and a government bond of the same maturity, indicate how the market prices credit risk.

For personal investing, yield helps compare bonds with different prices, coupons and maturities on a single scale. It also helps you judge whether a fund's distribution is attractive relative to risk and costs.

How to use it in practice

• Always ask which yield is quoted. Coupon, current yield and YTM can differ widely.
• Compare bonds with similar maturity and credit quality, or you are comparing different risks.
• For callable bonds, look at yield to worst, the lowest of the possible yield outcomes.
• Subtract inflation and taxes to understand your real return.
• Look at the yield of a bond fund, and note whether it is a trailing distribution yield or a forward-looking measure.
• Track the government yield of the currency you hold, since it influences the whole market.

Common mistakes and misconceptions

• Treating a high yield as a sign of quality. It often reflects higher default risk.
• Confusing coupon rate and yield.
• Forgetting that YTM assumes holding to maturity and full repayment.
• Assuming a quoted yield is what you will earn after costs, taxes and spread.
• Ignoring reinvestment risk, since coupons may be reinvested at lower rates.
• Believing falling yields always mean bad news. They can reflect lower inflation or lower borrowing costs.

Risks and limitations

Yield is a snapshot, and it is a forward-looking estimate, not a promise. If the bond is sold before maturity, the return depends on the selling price. Defaults, call features, inflation and exchange rates can all change the actual result. Different providers compute yields with slightly different conventions, so numbers may not match exactly across screens.

How Brokeli looks at it

Yield is a market data point, not a broker product. In our research we look at whether a broker offers bonds, bond ETFs or yield-linked instruments, and which instruments and costs are available by country, all based on published research snapshots. Where a broker displays yields, we note how they are defined.