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Bond Yields and Quotes

Bond Yields

The return of a bond is largely determined by its interest rate. The interest that a bond pays depends on a number of factors, including the prevailing interest rate and the creditworthiness of the issuer, which, of course, is what is assessed by the credit rating companies, such as Standard & Poor's and Moody's. The higher the credit rating of the issuer, the less interest the issuer has to offer to sell its bonds. The prevailing interest rate—the cost of money—is determined by the supply and demand of money. Like virtually anything else, the greater the supply and the lower the demand, the lesser the interest rate, and vice versa. An often used measure of the prevailing interest rate is the prime rate charged by banks to their best customers.

Nominal yield, or the coupon rate, is the stated rate of interest of the bond. This yield percentage is the percentage of par value, which is almost always $5,000 for municipal bonds, and $1,000 for all other bonds, that is usually paid twice a year. Thus, a bond that pays 5% interest pays $50 dollars per year in 2 semi-annual payments of $25. The return of a bond is the return/investment, or in the example just cited, $50/$1,000 = 5%.

The interest from municipal bonds are not taxed by the federal government. Hence, municipalities can pay a lower interest for its bonds than a corporation with a comparable credit rating. To compare municipal bonds with taxable bonds, the yield is converted to a taxable equivalent yield (TEY) = (Muni Yield)/(100% - Tax Bracket %).

Because bonds trade in the secondary market, they may sell for less or more than par value, which will yield an interest rate that is different from the nominal yield, called the current yield, or current return. The price of bonds moves in the opposite direction of interest rates. If rates go up, the price of bonds decrease; if the rates go down, then the bonds increase in value. To see why, consider this simple example. You buy a bond when it is issued for $1,000 that pays 8% interest. Suppose you want to sell the bond, but since you bought it, the interest rate has risen to 10%. You will have to sell your bond for less than what you paid, because why is somebody going to pay you $1,000 for a bond that pays 8% when they can buy a similar bond of equal credit rating and get 10%. So to sell your bond, you would have to sell it so that the $80 that is received per year in interest will be 10% of the selling price—in this case, $800, $200 less than what you paid for it. (Actually, the price probably wouldn't go this low, because the yield-to-maturity is greater in such a case, since if the bondholder keeps the bond until maturity, he will receive a price appreciation which is the difference between $1,000, the bond's par value and what he paid for it.) In such a case, the bond is said to be selling at a discount. If the interest rate of a new bond issue is lower than what you are getting, then you will be able to sell your bond at a higher price than what you paid—you will be selling your bond at a premium. The current yield = annual interest payment/price of bond.

Because current bond prices fluctuate, an investor can pay more or less than the par value for a bond. If the investor holds the bond until maturity, he will lose money if he paid a premium for the bond, and he will earn money if he paid for it at a discount. The yield-to-maturity, or true yield, of a bond that is held to maturity will have to account for the gain or loss that occurs when the par value is repaid. The formula for yield to maturity is complicated and difficult to solve, but it generally will yield an interest rate comparable to newly issued bonds with the same credit rating. The following formula is a

When a bond is bought at a discount, yield to maturity will always be greater than the current yield; when it is bought at a premium, the yield to maturity will always be less than the current yield.

Because some bonds are callable, these bonds will also have a yield-to-call ratio, which is calculated exactly the same as yield to maturity, but the call date is substituted for the maturity date and the call price is substituted for par value. When a bond is bought at a premium, the yield to call is always the lowest yield of the bond.

Zero coupon bonds pay no interest, but are sold at a discount to par value, which is paid when the bond matures.

Bond Quotes

When looking at bond quotes, you will notice that most of them hover around 100. Each bond point = $10; therefore, to get the actual bond price, you must multiply the quote by 10. Thus, a bond quote of 94.25 = an actual price of $942.50.

Federal government and agency bonds are also quoted in points of $10 each. Here's a quote for a 91 day Treasury Bill: 97.970194. T-Bills are sold at a discount, so to buy this, you would have to pay $979.70, and you would get $1,000 back when the Bill matures in 91 days. If you wanted to buy 1,000 T-Bills at this price, you would have to multiply this quote by 10,000 for a total cost of $979,701.94, then you would receive $1,000,000 back in 91 days.

Introduction to Bonds

Bond Ownership

Corporate Bonds

Municipal Bonds

Federal Government Securities

Ginnie Mae, Sallie Mae

Bond Ratings and Credit Risk

Bond Yields, Credit Risk, Taxable Equivalent Yield (TEY)

Repayment of Bond Principal

Special Bonds - Advanced Refunded Bonds, Put Bonds, Convertible Bonds

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