What is Bond Yield? Meaning and Their Importance

What Is Bond Yield?

Bond yield can be defined as the expected earnings from investment in a bond over a period of time. This is usually written as a percentage and explains the amount of money the bond will give you in relation to the initial purchase price. It’s a measure of how good or how bad a bond is likely to perform.

Essentially, bonds are debt given by investors to either governments or companies. In return, the bond issuer promises to pay back the principal amount on a certain date and also promises to make interest payments for your principal amount.

Types of Bond Yields

Here are the different types of yields you come across:

• Nominal Yield: This is the most basic form. It measures the bond's yearly coupon value against its face value. For instance, when a bond is purchased for Rs. 1,000 and an interest of Rs. 50 is received annually for that bond, and then the nominal yield is considered as 5% (= 50/1000), also referred to as the rate of return.
• Current Yield: Things get a bit more dynamic here. Current yield calculates how much the bond's annual interest payment is to its market price. If that ₹1,000 bond is trading at ₹950 in the market, the current yield would be higher than 5%. Moreover, if it trades at ₹1,050, the yield will be lower.
• Yield to Maturity (YTM): This type of bond yield is the most common and widely used for the appraisal method of valued investment. YTM calculates the overall return you would earn from holding a bond until its maturity, considering the interest payments and the difference between the purchase and selling prices.

Why Bond Yield Matters

Bond yields are crucial to evaluating the guidance investors have available. While a yield greater than a given baseline may look appealing, the risks associated with this, such as the risk of issuer default, are very high. Governmental bonds, for instance, tend to have a low yield as they are viewed as relatively less risky investments.

Bond yields provide important information about various economic matters. If bond yields increase, it may mean that interest rates or inflation expectations are increasing. Conversely, if bond yields decrease, economic uncertainty relative to a recession or depression may be on the horizon.

How Prices and Yields Are Connected

Here's something important to remember: when prices increase, yield decreases, and when prices decrease, yield increases. This relationship works because most interest payments on a bond are constant. Therefore, if the coupon amount is fixed, the yield depends on changes in the bond market value.

Conclusion

Bond yields may sound obsolete or technical, but they describe how much you can expect to be paid for what you invested in the bond. So, if you are a casual investor or a professional, it is important to know about yields to make financial decisions in the changing bond market.