The return that a bond provides investors is measured by its yield, which is quoted as a percentage. Current yield is a commonly quoted yield calculation used to evaluate the return on a bond for a one-year period. It only accounts for the interest, or coupon payments, that the bond returns to investors. This yield is calculated as the bond's coupon rate divided by its current market price, but doesn’t account for any capital gains or losses incurred when the bond is sold. If the bond isn’t sold within the year, this yield calculation will provide the bondholder with an accurate assessment of his or her return.
A bond's current yield can only be negative using this basic evaluation, if investors were receiving negative interest payments, or if the bond somehow had a market value below $0 – both of which are relatively rare events. Other yield calculations take into account different factors and can be used to better evaluate the returns investors may receive, given different events.
As its name suggests, the yield to maturity (YTM) calculates the bond’s return (expressed as an annual percentage), if investors were to hold the bond until maturity. This formula takes into account all of the coupon payments and the face – or par – value on the bond (assuming no principal defaults), and is deemed to be a more complete evaluation than current yield. However, calculating a bond's YTM is a complex maneuver that involves significant trial and error. While this is typically achieved by using a programmable business calculator, an approximate YTM may be gleaned from a bond yield table.
Consider an example where an investor pays $800 for a bond that has precisely two years to maturity, a face value of $1,000 and interest payments of $8 per year. In this scenario, a bond table will determine that the bond will have a YTM of about 10.86%. If the bond holder paid $1,200 for the bond, the YTM would be about -9.41%. However, it is worth noting that a bond will not necessarily present a negative actual yield, simply because the investor paid more than face value for it.
Finally, when using the YTM calculation, it is possible to have a negative yield on a bond, depending on how much one initially pays for the bond and the time to maturity.
Yields can be calculated using more than the two formulas articulated in this article, and different formulas may calculate drastically different yields. To learn more, see our Bond Basics Tutorial, Advanced Bond Concepts and Boost Bond Returns With Laddering.