Bond yield: calculation formula

2024 Author: Howard Calhoun | [email protected]. Last modified: 2024-01-02 13:48

Many novice investors are wondering how to calculate the yield on a bond using a formula. This topic deserves special mention, since securities can bring both fixed and dynamic income, which depends on many factors. This article will discuss how it will be easiest for a novice investor to make money on bonds.

What is a bond?

Before you understand how the yield of a bond is calculated using the formula, it is strongly recommended that you familiarize yourself with what this security is. Many investors very often confuse it with a stock, but their fundamental difference lies in the fact that bonds provide a fixed income, which is paid to the investor without fail. By purchasing shares, a person seems to be buying a pig in a poke and seriously risks his funds, because the enterprise in which he invested money cango bankrupt at any moment, and the shares - depreciate.

So, a bond is a security that certifies the relationship of a creditor (investor) with a borrower in the form of a legal entity (issuer). It should be understood that the bond not only provides a guarantee for the payment of the funds that the investor has invested in the enterprise, but also provides additional interest, which are called coupons (unless, of course, we are talking about coupon bonds). Depending on the established policy of the enterprise, coupons can be paid once a month, a quarter or even a year.

Methods of paying income

A novice investor should understand that the bond yield formula will not be the same in all cases, since there are various ways for borrowers to pay money. The list below shows only the main ones:

1. Fixed interest payment is the most common option.
2. Stepped interest rate - interest increases significantly over time.
3. Floating rate of interest income - the percentage floats from season to season.
4. Indexing the face value - paying the value of the bond.
5. Selling bonds at a discount - selling securities below par.

Depending on the chosen form of payments, the bond yield formula will also differ. However, do not be upset in advance! This article will provide all the necessary information on how to calculate profit frominvestment.

Couponless

Thinking about how to find out the current yield of a bond using the formula? To begin with, you will need to determine the type of security you have purchased or intend to purchase. For example, the zero-coupon bond yield formula is extremely simple, and even a novice investor can understand it.

Suppose that a certain company sells securities at 800 rubles apiece, but their nominal value is 1000 rubles. Such a move is called the sale of bonds at a discount. The investor will receive an income of 200 rubles from each paper, when the time comes and it can be sold at face value.

Coupon yield

What does the coupon bond yield formula look like? Everything is very simple. Coupon yield is the percentage that the issuer pays to its borrower in a certain period. Most often, payments are made quarterly, but some companies may issue securities whose coupons can be cashed out only once every six months or even a year. Although the interest rate of such bonds is usually slightly higher.

A small example will help you understand the essence of payments according to the formula for the current yield of a bond:

Annual Income=Nominal x Yield x Quantity

The face value of the bond is one thousand rubles, and the coupon yield is 8 percent. An investor can use four coupons per year. That is, the yield on the security will be 80 rubles per quarter and 320 rubles per year. How did it come aboutnumber? Let's start with 1%. To do this, you need to divide 1000 by 100. After that, we multiply one percent by 8 (we find 8% - the yield of one coupon) and multiply the resulting number by 4 coupons. This is how the coupon bond yield formula looks like. Everything is very simple and clear.

Current yield

To calculate the current yield of a fixed rate bond, you need to find the ratio of the periodic payment to the price at which the security was purchased. For example, the income from coupons is 100 rubles for six months, and the security was purchased at face value, which is 1000 rubles. In this case, it is necessary to divide 100 by 1000 - we will get a number equal to 0, 1, a pretty good indicator for a novice investor, especially if payments continue at least 10 times over 3-4 years. In this case, the final yield will be 1000 rubles. In addition, the investor will also return the face value, which will be equal to the same price. Hence, the net profit will be 100%. What business can boast the same payback in just three years?

Yield to maturity formula for a coupon bond

Coupon shares are securities, the profit from which is calculated on special coupons. It was mentioned above how to calculate the interest yield on a bond. However, in order to understand the formula for calculating the yield to maturity of bonds, it is necessary to introduce one more variable - the time after which the settlement with the investor will occur. For example, ifthe coupon yield on the bond is 250 rubles per year, and the security is designed for use within four years, then this number must be multiplied by four - we get 1000 rubles. To this amount we also add the nominal value of the bond, for example, 1500, and we get a number equal to 2500. However, if the shareholder has already managed to receive 500 rubles in coupons in two years, then five hundred must be subtracted from the final amount. As a result, the profitable repayment will be equal to two thousand.

Internal bond yield (formula)

Every professional investor knows that the intrinsic yield on a bond is the amount that can be earned on a security, not including the face value. This numerical value is also sometimes converted to a percentage in order to make it more convenient to calculate the return on investment. It is also worth understanding that not only coupon bonds have internal yields. For example, you purchased a security at a discount for 900 rubles, although its face value is 1150. In this case, the internal yield will be 250 rubles for the entire period of use. As for coupons, it's even easier with them. If the bond has an interest yield of $500 per year and the payments are made over three years, then the intrinsic value is $1,500 (5003). We will not even be interested in knowing the face value of the goods, since this formula does not take it into account.

Annual return

Of course, after reading everything, determinethe annual yield of a bond according to the formula will not be difficult, especially if you have carefully delved into the information that was provided earlier. As a rule, the annual yield is calculated only for coupon securities. First, we look for the coupon yield for one year. Let's say it is 200 rubles. However, the nominal value must also be added to this amount, after dividing it by the number of years that the bond will serve its owner. For example, the face value of a security is 1200 rubles, and the service life is 5 years. It turns out that the annual yield will be equal to 440 rubles (1200 / 5 + 200).

It's much more complicated when a bond has a floating interest rate. In this case, the annual return is the average of the results obtained over several years. For example, for one year the yield was 500 rubles, and for the second - 1000. In this case, the average figure will be equal to 750 rubles, which will be the annual yield of the security. However, be sure to add the face value of the bond before you start calculating the average.

How is the price of a bond calculated?

Any investor who decided to invest in the acquisition of these securities at least once asked a similar question. It should be understood that bonds have not only a nominal value, but also a market value, which depends on this rate. To calculate it, you need to follow a certain formula. We take the market price of the security (how much it is offered to owners on the market), divide it by the nominalcost and multiply by 100%:

• S=P_ts / H_{ts x 100.}

Let's say you bought several securities with a face value of 500 rubles. However, after a few years, the enterprise to which you provided the loan developed very strongly, and the value of the securities increased to 750 rubles. In this case, calculating the bond rate will be quite simple. We take as a dividend the market value - 750 rubles and divide it by a fixed face value - 500 rubles. We get a number equal to 1.5. All that remains is to multiply this figure by 100% - it turns out that the bond rate is 150%.

Comparing bonds to stocks

The peculiarity of bonds is that their face value, unlike the same shares, is always at a certain level. Therefore, the investor practically does not risk his money by investing it in the purchase of bonds. However, this does not mean that cash deposits of this kind are completely safe. The enterprise can go bankrupt and stop paying coupon income, and also keep the face value. Of course, if we are not talking about government bonds issued by the Ministry of Finance.

In turn, stocks are a great opportunity for a literate person to increase their capital in a short period of time. For example, you can buy securities of some promising company, and then resell them ten times in a few months.expensive! However, such opportunities are also associated with great risk, since shares can also depreciate, even if we are talking about state-owned enterprises. Although there is a certain group of companies, the contribution of funds to which is accompanied by minimal risk. Such companies are called "blue chips".

Conclusion

As you can see, the calculation formulas for bond yields help to quickly and accurately determine the prospects for investing in a particular enterprise. The information in this article should be enough for a beginner investor, but if you still have any questions, it is highly recommended to watch a short video in which a professional investor explains everything about how to make money on bonds.

As you can see, a bond is a pretty good source of income, which you should definitely think about for those people who have finances, but who do not like to take risks. Buying securities will also protect your money from inflation, as well as guarantee you a return on investment, which joint-stock companies (even from the blue chip category) cannot boast of. Although if you are attracted to risk and excitement, you may well invest in buying shares and live on income from dividends, which very often exceed income from coupons.