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Understanding the concept of yields on bonds
Coupon Yield: Coupon yield is the percentage of principal or face value of the bond. It is the annual interest payment rate of a bond. Coupon yield is the fixed return the bond issuer commits to a bond holder and thus do not incorporate fluctuations in interest rate. Since, coupon yield is based on face value of the bond so it remains the same throughout the lifespan of the bond.
Coupon yield is calculated as follows:
Coupon Yield = Coupon payment / Par value of the bond.
To understand clearly we take an example. We consider a bond with a face value of Rs.1000. Now, let the annualised coupon payment be Rs.55.
Then, coupon yield = 55/1000 = 5.5%.
Current Yield: Current yield is the annual interest payment divided by its market price. So, it is the annual interest payment as a percentage of the bond's market price. Therefore, it denotes the yield at the current moment only and not the total return throughout the lifespan of the bond.
Current yield = (Annual Interest payment/Market price) X 100
In our example, the annualised coupon payment is Rs.55 and let us consider that the market price of the bond is Rs.1030.
Then, current yield = (55/1030) X 100 = 5.34%.
Yield to Maturity (YTM): It is the expected rate of return at the end of maturity period of the bond and reinvest all the interest payment at the same rate as the current yield on the bond. It takes into account all the interest payment received, gain (if purchased at a discount) or loss (if purchased at a premium).
Click here to know more about investments options in bonds.
Conclusion
If you invest in bonds then you must have a clear idea on bond yields. YTM gives a more accurate picture on the yield and help you to do a comparative study on bonds with different maturities and coupons.
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