A Bond’s Yield is its annual return to an investor based on its price, coupon rate, and how long the investor holds it before it matures or is sold. The yield may not match the stated interest rate on the bond.
If a bond’s coupon rate is higher than market interest rates, the bond will trade for more than its par value, or at a premium. For example, if current interest rates are 3 percent, a bond with a $5,000 par value and a 4 percent coupon may sell for $5,430. Although the investor will receive higher interest payments than it would have if it had purchased another bond with a lower coupon, it paid an additional $430 up front to purchase the bond. Thus, the bond’s yield, which takes into account both the bond’s price and coupon, will be lower than the 4 percent coupon rate.
Multiple yields may be calculated for the same bond based on structure and how long the investor holds it:
· Yield to maturity (YTM) assumes the investor will hold the bond until it matures
· Yield to call (YTC) assumes the issuer will pay off the bond before its maturity date
· Yield to put (YTP) assumes the investor will force the issuer to repurchase the bond before it matures
· Yield to worst (YTW) is the lowest of yield to maturity, yield to call, and any other associated calculation