Besides understanding types of investments, investors also need to understand what bond yield is. This is because yield is one of the important concepts in the world of bond investment, yet it is still often overlooked or not fully understood by investors.
Simply put, bond yield is the return or income obtained from investing in bonds. In practice, bond yield is an important tool for investors, portfolio managers, and entrepreneurs to make appropriate investment decisions, plan effective finances, and understand risks associated with bonds and financial markets as a whole. It is an important indicator that can help individuals and organizations achieve their financial goals.
Key Takeaways:
- Bond yield refers to the expected rate of return from bond investment, expressed as an annual percentage.
- There are many methods for calculating bond yield, and each of these methods can explain different aspects of potential risk and return.
- In bond investment, price and yield are inversely related, meaning when bond prices rise, their yield will fall.
Types of Bond Yields
One important thing that must be examined when conducting feasibility assessments for bond investments is evaluating bond yield or interest rate return levels. This bond yield evaluation can be done in several different ways and produces different conclusions as well. Additionally, certain types of yield calculations also depend on the type of bond or fixed-income security being analyzed.
Some of these different types of bond yields include what are called current yield, nominal yield, yield to maturity (YTM), yield to call (YTC), and yield to worst (YTW). We will discuss each type of yield below.
Current Yield
This is a type of annual bond yield measurement represented as a percentage of the current market value or price of the bond. Current yield is a fairly simple measurement that tells investors what they can expect for returns in the current market.
When used to describe a portfolio, current yield refers to the cumulative yield or return from all investments currently held in that portfolio. This type of yield is somewhat similar to dividend yield, but instead of describing individual assets, it describes the entire group represented in the portfolio as a whole.
Nominal Yield
Nominal yield is the bond yield determined by the percentage of par value paid by the bond's annual coupon. This means nominal yield is effectively the bond's coupon rate. This rate may or may not change depending on the type of bond:
Fixed Interest Rate Bonds: The coupon rate or nominal yield will remain fixed and will not change during the bond's term.
Floating Interest Rate Bonds: Coupon payments will change according to the reference interest rate. However, nominal yield is still calculated based on the initial coupon against par value.
Indexed Bonds: Coupon payments/nominal yield will change in response to movements in its reference index.
Yield to Maturity (YTM)
YTM describes the average yield or return that investors can expect from a bond annually if they buy it at market value and hold it until maturity. This value is determined by the bond's coupon rate, market price, and period until the call date, not until maturity.
YTM estimates usually assume that all coupon payments are reinvested at the same rate of return until maturity. This figure is used to compare various different bonds that investors want to choose from, and is one of the key figures for comparing bonds. This is due to the fact that this figure includes more variables than other comparative figures.
Yield to Call (YTC)
Yield to call simply refers to the bond's yield at the call date. This value does not apply if the bond is held until maturity, but only describes the value at the call date, which, if any, can be found in the bond prospectus. This value is determined by the bond's coupon rate, market price, and length of the maturity date.
Yield to Worst (YTW)
As the name suggests, yield to worst describes the worst possible yield that could occur on a bond without the bond issuer experiencing default. Investors determine this by imagining the worst-case scenario for yield.
This scenario includes all provisions within the bond such as yield to call, prepayments, or any sinking funds that would negatively impact the bond's yield. By knowing the worst possible yield that could occur, investors can understand the minimum potential return from that bond.
Bond Yield vs Bond Price
Price and yield are inversely related. This means when bond prices rise, their yield falls. Conversely, when yield rises, bond prices fall.
If an investor buys a bond with a par value of 15 million rupiah and maturity in five years with a coupon rate of 10% per year, then that bond will pay interest of 10% or 1.5 million rupiah per year. If interest rates rise above 10%, the bond price will fall if the investor decides to sell it.
If interest rates for similar investments rise to 12%, the original bond will still receive coupon payments of 1.5 million rupiah, making it unfavorable for investors who would buy the bond for 15.3 million rupiah because interest rates have risen. Therefore, in selling the original bond for 15 million rupiah, the price of that debt security can be lowered first so that income from coupons and maturity value equals a 12% yield.
If interest rates fall, bond prices will rise because coupon payments become more attractive. The further interest rates fall, the higher bond prices will rise. In both scenarios, the coupon rate no longer has meaning for new investors. However, if annual coupon payments are divided by the bond price, investors can calculate current yield and get an estimate of the bond's actual yield.
Trust Your Investment with BTN Prioritas
Bond yield is an important factor for investors because it affects their investment returns. A good understanding of yield helps investors make better decisions about allocating their funds across various financial instruments, including bonds. Additionally, yield can also be used to compare bonds with different risk levels.
Furthermore, bonds themselves have a positive stigma as one of the safest investment vehicles in the market. And various bond yields can tell you a lot about how much investment risk there is and the returns you might get.
If you are unsure which bonds or investments are best for you, perhaps it's time to get to know more about the investment products available at BTN Prioritas. Specifically for bond products, BTN Prioritas offers two main options: secondary market bonds and primary market bonds.
If you are interested in learning more about the explanation of each available investment product, you can directly visit our website or contact us via email at btncontactcenter@btn.co.id
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