How are bond yields calculated?

by Manshu on December 30, 2008

in Articles

Bond Yields can be calculated in a few different ways, and, we will look at two common ones here. The first one is: Current Yield.

Current Yield

This is really simple to calculate, and, you just need to know three things –

  1. Coupon Rate
  2. Par Value
  3. Price of the Bond

The formula to calculate the yield is  – {(Coupon Rate  x Par Value) / Price of the Bond} x 100.

For example, if the Coupon Rate is 5%, Par Value $100 and Price of the Bond 90$ the:

Yield is – {(.05 x 100) / 90} x 100 = 5.56%

This is the simplest way of calculating bond yields. Basically, what this number tells you is – you are getting a 5.56% return in an year for every dollar that you spend to  buy the bond. The drawback of using this method is that it assumes that the bond price will not move up or down and doesn’t care how long the bond is issued for.

Adjusted Current Yield

This method incorporates the capital gains or losses due to price movements, into the calculation of yield, and, therefore is more accurate than the current yield method.

To include the capital gains or losses; you need to consider the time it takes for the bond to mature on top of the other factors used for current yield.

Say in our current example, the bond matures in 2 years. Then the capital gains calculation will be as follows:

{(100 – Market Price) / Years to Maturity}

{(100 – 90) / 2} = 5

If you add the above number to the current yield; you will get the Adjusted Current Yield. So, in our example:

5.56 + 5 = 10.56%

What do these calculations exclude?

The Current Yield and Adjusted Current Yield exclude the – Time Value of Money, Zero Coupon Bonds and bonds bought between coupon payments. The bond yields on sites Yahoo Finance incorporates all these calculations and then present it.

{ 2 comments… read them below or add one }

Dr.Arvind jadhav August 16, 2012 at 3:42 pm

There must be a simple way to calculate annual yield on these bonds.
What are other different ways to calculate, please mention.
Thanks.

Reply

Manshu August 20, 2012 at 8:29 pm

Simplest way is called current yield, where you take the market price and divide it by interest rate. It is not as effective as the more elaborate methods though since it doesn’t take into account other factors like how much time has lapsed since last payment, how many years to maturity are left etc.

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