BOND ANALYSIS – BOND

RETURN / BOND YIELD

 BOND YIELD
• Yield is the return an investor will receive
by holding a bond to maturity.
• Yield is the return on an investment,
expressed as an annual percentage.
For example, a 6% yield means that the
investment averages 6% return each
year. Thus, when you buy bonds, you
generally seek higher yielding bonds,
other factors being equal.
 REQUIRED YIELD
• Required yield, on the other hand, is the
yield or return a bond must offer in order
for it to be worthwhile for the investor. The
required yield of a bond is usually the yield
offered by other plain vanilla bonds that
are currently offered in the market and
have similar credit quality and maturity.
BOND RETURNS / BOND YIELDS
• Bond returns can be calculated in a
number of ways:
1. CURRENT YIELD;
2. YIELD TO MATURITY;
3. YIELD TO CALL.
 CURRENT YIELD
• The current yield calculates the
percentage return that the annual coupon
payment provides the investor.
• In other words, this yield calculates what
percentage the actual dollar coupon
payment is of the price the investor pays
for the bond.
 CURRENT YIELD
• Current yield is the simplest way to
calculate yield: For example, if you buy
a bond paying $1,200 each year and
you pay $20,000 for it, its current yield
is 6%.While current yield is easy to
calculate, it is not as accurate a
measure as yield to maturity.
 CURRENT YIELD
1. Calculate the current yield of a bond
which is priced at $95.75 and has an
annual coupon of $5.10. the current yield
of the bond is 5.33%.
2. Calculate the current yield of a bond with
a par value of $100 for $95.92 which
pays a coupon rate of 5%.
 LIMITATIONS OF CURRENT
YIELD
• Does not include any capital gains or
losses the investor would make if the bond
were bought at a discount or premium.
• Current yield calculation does not take into
account the time value of money or, more
specifically, the present value of the
coupon payments the investor will receive
in the future
 YIELD TO MATURITY
• YTM is the yield promised by the
bondholder on the assumption that the
bond will be held to maturity, that all
coupon and principal payments will be
made and coupon payments are
reinvested at the bond's promised yield at
the same rate as invested. It is a
measurement of the return of the bond.
 NO DEFAULT
• The yield to maturity is the rate of return
obtained by buying a bond at the current
market price and holding it to maturity.
• In the calculation of the yield to maturity,
one assumes that there will be no default:
all payments will be made as promised.
• If there is default, then the rate of return
actually achieved is less than the yield to
maturity.
PREMIUM & DISCOUNT BONDS

• Premium bond: Coupon rate is

greater than market interest rates.

• Discount bond: Coupon rate is less

than market interest rates.
Relationship between a bond's
price and its yield
• In general, as a bond's price increases,
yield decreases.
• This is due to the fact that a bond's price
will be higher when it pays a coupon that
is higher than prevailing interest rates. As
market interest rates increase, bond prices
decrease.
 YIELD TO MATURITY
• Is the interest rate by which the present
values of all the future cash flows are
equal to the bond's price.
• Yield to maturity is often the yield that
investors inquire about when
considering a bond.
• The most important rate of return
indicator is a bond's yield to maturity.
 YIELD TO MATURITY
It considers the following factors
1. Coupon rate - The higher a bond's coupon
rate, the higher its yield. That's because
each year the bond will pay a higher
percentage of its face value as interest.• 
2. Price - The higher a bond's price, the lower
its yield. That's because an investor buying
the bond has to pay more for the same
return.•
 YIELD TO MATURITY
3. Years remaining until maturity - Yield to
maturity factors in the compound interest
you can earn on a bond if you reinvest
your interest payments.
4. Difference between face value and price
- If you keep a bond to maturity, you
receive the bond's face value. The
amount you receive may be more or less
than the price you paid.
 YIELD TO MATURITY
• YTM is defined as the interest rate that
makes the present value of a bond’s
payments equal to its price.
• This interest is often viewed as a measure
of the average rate of return that will be
earned on a bond if it is bought now and
held until maturity.
 Calculating Yield to Maturity
• A 5% bond priced at $850 and maturing in
15 years would calculate as follows:
Yearly Coupon Interest = $50 (5% paid to
$1000)
Total Discount = $150 ($100 par - cost of
$850)
Annual Discount = $10 ($150 total
discount divided by 15 years)
 Calculating Yield to Maturity
• Average price - $925 (difference between
$850 and $1000 par)

• Add the $10 annual discount to the

coupon payment of $50. This gives you
$60, which is divided by $925 and that will
give you the yield to maturity of this bond -
6.49%
 Calculating Yield to Maturity
• Yield to Maturity – 6.49% > Nominal
discount of 5%.
 NOMINAL RATE
• The Nominal rate or coupon rate is
the fixed interest rate on the bond.
This is the rate that the issuer pays
to par value. It is fixed, it never
changes and it is only paid to par.
YTM for BONDS PURCHASED
AT A PREMIUM
• If a bond has a 7% nominal yield or
coupon and was purchased at a premium
of $103 ($1030), then your YTM will
calculate lower because the 7% interest is
only paid to the $1000 par. The $30
premium does not earn interest and is not
redeemable at par.
YTM for BONDS PURCHASED
AT A PREMIUM

YTM < Nominal Rate

YTM for BONDS PURCHASED
AT A DISCOUNT
• A bond purchased at a discount will have
the reverse affect on yield.
• The Yield to maturity would be higher for a
discount bond, based on the fact that you
are still earning interest on par even if you
paid under par.
YTM for BONDS PURCHASED AT
A DISCOUNT

YTM > Nominal Rate

 YIELD TO MATURITY
• If a bond's current yield is less than its
YTM, then the bond is selling at a
discount.
• If a bond's current yield is more than its
YTM, then the bond is selling at a
premium.
• If a bond's current yield is equal to its
YTM, then the bond is selling at par.
 YIELD TO MATURITY
• Calculate the YTM for an 8% coupon, 30
year bond which is selling at $ 1,276.76?
Yield to maturity > required rate of return

Buys

Yield to maturity < required rate of return

Does not buy

Yield to maturity = required rate of return

Normally Buys
CALCULATING YIELD TO
MATURITY USING
FORMULA
Current market price of bond
(available from bond market)
= C/ (1 + YTM) + C/ (1 +

YTM) 2 + C/ (1 + YTM) 3 + … +

C/ (1 + YTM) T + N/ (1 + YTM) T

YTM : Yield to maturity

 Example:
A bond has the following
characteristics:
Coupon rate 5%, nominal value
Rs1000 and maturity 2 years.

If the market price of the bond is

equal to Rs960, calculate the yield
to maturity of the bond.
960 = 50/ (1 + YTM) + 50/ (1 +

YTM) 2 + 1000/ (1 + YTM) 2

Multiply both sides by 1/ (1 + YTM) 2 and

simplify:

960 (1 + YTM) 2 - 50 (1 + YTM)

– 1050 = 0
Assume (1 + YTM) = A

960 A 2 – 50 A – 1050 = 0

Use quadratic equation formula to

solve

YTM = 7.2191%
 YTM
• Suppose your bond is selling for $950, and
has a coupon rate of 7%; it matures in 4
years, and the par value is $1000. What is
the YTM?
 YTM
• The coupon payment is $70 (that's 7% of
$1000), so the equation to satisfy is

70 /(1 + r)1 + 70 / (1 + r)2 + 70/(1 + r)3 + 70/

(1 + r)4 + 1000/(1 + r)4 = 950