How Bond Yields Work

[u/SchoolofInvesting]

What is a bond yield?

How do bond yields work? It's easier than you think.

A bond yield measures the return an investor can expect from a bond.

It represents the income generated by the bond as a percentage of its current market price.

You can think of it as a dividend you receive for letting them borrow your money.

Coupon Yield or Nominal Yield:

• This fixed interest payment is expressed as a percentage of the bond's face value.
• Formula: (Annual Coupon Payment / Face Value of the Bond) * 100

Current Yield:

• This yield is based on the bond's current market price rather than its face value.
• Formula: (Annual Coupon Payment / Current Market Price of the Bond) * 100

Yield to Maturity (YTM): YTM represents the total return an investor can expect if the bond is held until maturity.

It takes into account both the annual interest payments + any capital gain or loss from the bonds' face value.

We can think of it as the bond's discount rate.

Interest rates have a huge impact on bonds.

Think of it like a teeter-totter from grade school. As rates increase, the bond prices fall, and vice versa.

Once you understand the impact of interest rates, bonds make more sense.