It is possible but unlikely that a bond can have a negative yield. To understand how that can happen you have to know how the yield on a bond is determined.
And remember: This is relevant mainly to bond traders who buy and sell bonds in the secondary market, not to individual investors who buy bonds at face value and hold them until their maturity date.
Understanding Bond Yield
The return that a bond provides an investor is measured by its yield, which is a percentage of the bond's face value. "Current yield" is the commonly quoted number that is used to report the return on a bond for a one-year period.
- Current yield is the amount that will be paid in interest on a bond over a one-year period, expressed as a percentage of its face value.
- Yield to maturity is the amount that will be paid from now until the bond expires, also expressed as a percentage of its face value.
- The yield to maturity may in rare circumstances be a negative number.
Note that this accounts only for the interest amount, or coupon payments, that the bond pays to the investor. The current yield is calculated by dividing the bond's coupon rate by its current market price. That number doesn’t account for any capital gains or losses incurred when the bond is sold.
If the bond is held by the investor for one year, this yield as quoted will accurately reflect the total return that the bondholder has received.
Using this calculation, the bond's current yield can only be negative if the investor received a negative interest payment, or if the bond had a market value below zero. Both of these are unlikely events.
Calculating Yield to Maturity
Other calculations of yield take additional factors into account and can be used to more accurately evaluate the returns an investor may receive.
As its name suggests, the yield to maturity (YTM) indicates the bond’s return, expressed as an annual percentage, if the investor holds the bond until it reaches its maturity date. This formula takes into account all of the coupon payments and the face (or par) value on the bond.
This is generally seen as a more accurate evaluation of a bond's value than current yield.
Example of YTM Calculation
However, calculating a bond's YTM is complex and involves significant trial and error. While it is usually done by using a software program, an approximate YTM can be obtained from a bond yield table.
A bond may have a negative YTM calculation. It depends on how much less than par value the investor paid for it and how many payments will be made before it reaches its maturity.
For example, say an investor pays $800 for a bond that has exactly two years left to maturity. It has a face value of $1,000 and interest payments of $8 per year.
In this scenario, the bond table will show that the bond will have a YTM of about 10.86%. If the bondholder had paid $1,200 for the bond, the YTM would be about -9.41%.
However, 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 its time to maturity.
The Global Negative-Yield Problem
All of the above is related to the normal functioning of the bond market in the U.S. As of late-2020, more than a quarter of global bond debt had a negative yield. This is because, in an era of extremely low interest rates, many large institutional investors were willing to pay a little over face value for high-quality bonds. They accepted a negative return on their investment for the safety and liquidity that high-quality government and corporate bonds offer.