GuideBond Yields
What types of yield should investors be aware of?
| Yield To Maturity | Yield to Call | Yield to Average Life | Yield to Worst | |
|---|---|---|---|---|
| Notation | YTM | YTC | YAL | YTW |
| Relevance | All Bonds | Callable Bonds | Sinkable Bonds | Bonds with embedded options or non-regular structures |
| Redemption Date | Maturity Date | Call Date | Average Life | Maturity Date, Call Date or Average Life |
| Definition | Rate of return when holding a Eurobond until its maturity date and receiving 100% of the principal | Rate of return using the call date as the maturity date and the call price as the redemption price. The call price is usually set at a premium. | Instead of using the Eurobond’s maturity date, YAL calculation uses the average maturity. Most sinkable bonds start paying back the principal in equal instalments two/three years prior to maturity. Repayment of the principal and the existence of a sinking fund are usually seen as comforting to investors. | Compares a bond’s YTM, YTC or YAL and presents the lowest. |
Yield to Maturity is sometimes referred to as “Gross Redemption Yield” or simply “Redemption Yield”.
What is the difference between yield and coupon rate?
Some investors believe the coupon rate is the rate of return received when purchasing the bond. This is only true when the bond is bought at exactly 100% of its value, or at par. In other words, a bond priced at 100% (par) will have a yield (to maturity) equal to its coupon rate.
When a bond trades at more than 100% of it's value it is said to trade "at a premium". This may be the case due to high demand for example. Bonds trading at a premium have their yield below their coupon rate. Although the coupon is fixed (unless it's a floating or variable coupon), some of the future coupon income is needed to cover for the additional cost faced when purchasing the bond at a premium price. This is because investors will receive "only" 100% of the investment value back when the bond expires and therefore anything paid in excess of this will have to come out of coupon income.
The opposite holds for a discounted cash price, which will be accompanied with a yield higher than the coupon rate.
I is important to note that a coupon rate is like the interest rate on a loan. A bond issuer will pay a coupon rate over the nominal amount it has borrowed through the bond market irrespective of the price of that bond.
What is the difference between Current Yield and Yield to Maturity?
Simply dividing the coupon rate by the clean bond price, will give you the current yield of a bond. A bond paying a 5.00% coupon rate and currently trading at 99.00% has a Current Yield of (5.00%/99.00%) * 100% ≈ 5.05%.
A more balanced understanding can be derived from the Yield To Maturity (“YTM”) of a bond. Instead of a single coupon, a Yield to Maturity calculation uses all coupon payments expected over the life of a bond and presents a single rate of return by discounting these coupons using a discount rate.
A YTM approach assumes that the bond will be held until its maturity, the issuer keeps paying the coupon and coupon payments are reinvested at the same rate of return when received.