Bond Yields

When investing in bonds, it is essential to consider not only the coupon rate but also the yield. If two bonds have similar terms and credit ratings, the bond with the higher yield will have greater potential investment value. The price at which the bond is purchased will affect its yield, which may be higher or lower than the coupon rate. Current yield, yield to maturity (YTM), and yield to call (YTC) are the three commonly used bond yield measures.

• Current yield- the annualised rate of return calculated by simply dividing the current annual coupon of a bond by its price.
• YTM - the rate of return anticipated on a bond if it is held until maturity. YTM is usually expressed as an annual rate of return.
• YTC - the rate of return of a callable bond which is held until the call date. The yield will only become valid if the bond is called before maturity.

The yield represents the actual return on bond investment. Even if a bond has a high coupon rate, its yield may not correspondingly be high, and the two should not be confused.

However, there are many reasons why a bond with a high yield may not be a suitable investment choice. Generally, issuers of low-rated bonds need to offer higher interest rates to entice investors. Also, a bond with longer maturity normally has a higher yield unless the yield curve is inverted at the time of issuance. You have to be comfortable with the additional risks that you are taking.

The prices of bonds traded in the secondary market can vary due to a variety of factors. The yield will change accordingly. Generally, the relationship between yield and price is as follows:

• If you buy a bond at par and hold it until it matures, then the yield is the same as the coupon rate.
• If you buy a bond at a price higher than its par value, i.e. at a premium, the yield is lower than the coupon rate.
• If you buy a bond at a price lower than its par value, i.e. at a discount, the yield is higher than the coupon rate.

When you buy a bond, you become a creditor of the issuer. The issuer's creditworthiness reflects its ability to pay you what you are owed which, in the case of a bond, is the interest and/or the principal. Some bonds may have a guarantor to back the obligations and liabilities of the issuer. Investors can also refer to the credit rating of the issuer of the bonds, or of the bonds themselves, assigned by credit rating agencies, such as Standard & Poor's, Moody's, etc. The credit rating agencies will assign higher rating to the bonds which, in their opinion, the bondholders may have a better chance of receiving a payment for the principal and interest of the bond. However, investors should be aware that the credit rating is only an opinion of the credit rating agency and may change from time to time.

The yield on a bond is influenced by the credit risk of the bond. In general, the higher the credit risk, the higher is its yield due to the higher credit spread. Credit spread is the additional risk premium that investors demand for holding the bond. Therefore, non-investment grade bonds are also called high yield bonds or junk bonds due to the fact that they offer higher yield for the higher risks they carry.

Consult your intermediary for the latest credit rating of bonds. Credit rating agencies look at other debt the issuer has, its financial condition - how fast the issuer's revenues and profits are growing, and how well other companies in the same business are doing etc. Their primary concern is to alert investors to the risks of a particular issue.

Each credit rating agency has defined its own credit rating scale and separate sets of scale for long term and short term bonds.