Now that you know the different flavors of government bonds, it is time to learn how yields are computed.
Nominal Yield (Coupon Rate)
Say you bought a $1,000 par value bond with a coupon rate of 10% per year. Let\'s not worry about timing of payments right now and just assume that, on the last day of the year, you get your $100 interest payment ($1,000 x 10% = $100). But wait - you did not buy that bond directly from the issuer. You bought it on the open market for $750, so your yield is 13.3% ($100/$750). You still get the same $100, but on an investment of $750, not $1,000.
Yield to Maturity
Considers the current market price, the coupon rate and the time to maturity and assumes that interest payments are reinvested at the bond's coupon rate. This is the most accurate, and most widely quoted, measure of return on a bond.
Exam Tips and Tricks
You may need to identify yield to maturity on the Series 7 exam, but you will probably not need to perform the complex calculation.
Computing T-bill Discount Yield
InvestingInvestors base investing decisions and strategies on yield to maturity more so than coupon rates.
InvestingUnderstanding this relationship can help an investor in any market.
InvestingCoupon rate is the stated interest rate on a fixed income security.
InvestingLearn about how investors should evaluate bond performance. See how the maturity of a bond can impact its exposure to interest rate risk.
InvestingAny investor, private or institutional, should be aware of the diverse types and calculations of bond yields before an actual investment.
InvestingIn the financial world, “coupon” represents the interest rate on a bond.
InvestingYield to maturity is a basic investing concept used by investors to compare bonds of different coupons and times until maturity.
InvestingA bond with a par value – or face value -- of $1,000 is selling at a premium when its price exceeds par.