Bond Yields
Understanding bond yields is essential for comparing bond investments and appears frequently on the SIE exam. Different yield calculations tell you different things about a bond's return, and the relationships between these yields reveal whether a bond is trading at a premium or discount.
Types of Bond Yields
There are four main yield calculations you need to know:
| Yield Type | Also Called | What It Measures |
|---|---|---|
| Nominal Yield | Coupon Rate | Annual interest as % of par value |
| Current Yield | CY | Annual interest as % of market price |
| Yield to Maturity | YTM, Basis | Total return if held to maturity |
| Yield to Call | YTC | Total return if bond is called early |
Nominal Yield (Coupon Rate)
Nominal yield is the annual interest rate stated on the bond certificate. It never changes over the life of the bond.
Nominal Yield = Annual Interest ÷ Par Value
Example: A 7% bond pays $70 per year in interest (7% × $1,000 par). The nominal yield is always 7%, regardless of what happens to the market price.
The nominal yield is simply the coupon rate—the rate established when the bond was issued.
Current Yield
Current yield measures the annual return based on the bond's current market price, not its par value.
Current Yield = Annual Interest ÷ Current Market Price
Example: A bond with a 6% coupon ($60 annual interest) trades at $950. Current Yield = $60 ÷ $950 = 6.32%
Current Yield vs. Nominal Yield
| Bond Price | Nominal vs. Current Yield |
|---|---|
| At par ($1,000) | Nominal = Current Yield |
| At discount (below par) | Current Yield > Nominal Yield |
| At premium (above par) | Current Yield < Nominal Yield |
Yield to Maturity (YTM)
Yield to maturity (YTM) is the total return an investor will receive if they hold the bond until maturity. It accounts for:
- Annual interest payments
- Any capital gain or loss at maturity
- Time value of money
YTM is considered the most comprehensive measure of a bond's return.
Key Point: YTM assumes the investor reinvests all interest payments at the same rate. The actual formula is complex and will not be tested—focus on understanding the concept and relationships.
YTM and Bond Prices
| Bond Type | YTM vs. Coupon Rate |
|---|---|
| Par bond | YTM = Coupon Rate |
| Discount bond | YTM > Coupon Rate |
| Premium bond | YTM < Coupon Rate |
Yield to Call (YTC)
Yield to call (YTC) calculates the return if the bond is called (redeemed early) at the first call date. This is relevant for callable bonds.
- Uses call price instead of par value
- Uses call date instead of maturity date
- Important when a bond trades at a premium
When YTC Matters: If a bond is trading at a significant premium, investors should calculate YTC because the issuer is likely to call the bond if interest rates have fallen.
The Yield Relationships (Critical for Exam)
The relationship between the four yields tells you whether a bond is at premium or discount. This is heavily tested on the SIE exam.
Discount Bond Yield Order
For bonds trading at a discount (below par):
Nominal Yield < Current Yield < YTM < YTC
(lowest) (highest)
Memory Tip: Discount bonds have "increasing yields" as you move from nominal to YTC.
Premium Bond Yield Order
For bonds trading at a premium (above par):
YTC < YTM < Current Yield < Nominal Yield
(lowest) (highest)
Memory Tip: Premium bonds have "decreasing yields" as you move from nominal to YTC—the opposite of discount bonds.
Par Bond Yields
When a bond trades at par, all yields are equal:
Nominal = Current Yield = YTM = YTC
The Bond See-Saw (Visual Memory Aid)
Think of yields like a see-saw:
| Discount (Price < Par) | Par (Price = Par) | Premium (Price > Par) |
|---|---|---|
| NY < CY < YTM < YTC | All yields equal | YTC < YTM < CY < NY |
| Yields increase → | Balanced | ← Yields decrease |
Quick Calculation Examples
Current Yield Practice
| Bond | Coupon | Market Price | Current Yield |
|---|---|---|---|
| A | 5% ($50) | $1,000 | $50 ÷ $1,000 = 5.00% |
| B | 6% ($60) | $900 | $60 ÷ $900 = 6.67% |
| C | 8% ($80) | $1,100 | $80 ÷ $1,100 = 7.27% |
Notice: Bond B (discount) has CY > NY. Bond C (premium) has CY < NY.
Key Takeaways
- Nominal yield (coupon) is fixed and never changes
- Current yield reflects today's return based on market price
- YTM is the most complete measure of return (includes capital gain/loss)
- YTC applies to callable bonds and uses the call price
- Discount bonds: NY < CY < YTM < YTC
- Premium bonds: YTC < YTM < CY < NY
- Know the yield relationships—they are frequently tested!
A bond with a 5% coupon rate is currently trading at $900. What is the current yield?
For a bond trading at a premium, which yield is typically the LOWEST?
A bond is trading at par. Which statement about its yields is TRUE?
2.7 U.S. Treasury Securities
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