Now that you know the different flavors of government bonds, it is time to learn how yields are computed.

Nominal Yield (Coupon Rate)

  • The interest rate defined on the coupon.
  • This is generally the interest rate you receive if:
    • you acquired the bond at par (that is, at neither a discount nor a premium to its par value)
    • there is no call feature on the bond
    • you don't reinvest coupon payments and,
    • you are resolved to hold the bond until maturity
  • In reality, it is almost certainly not your actual interest rate.

Current Yield

  • Factors in the bond's market price, which is generally not the same as par value.
  • Consider the following application:
    Look Out!
    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

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