Many novice investors are wondering how to calculate the yield from a bond using the formula. This topic deserves special mention, since securities can bring both fixed and dynamic income, which depends on many factors. This article will discuss how the easiest way for a novice investor to make money on bonds.
What is a bond?
Before you figure out how the yield of a bond is calculated using the formula, it is strongly recommended that you familiarize yourself with what this security is. Many investors often confuse it with a stock, but their fundamental difference is that bonds give a fixed income, which is paid to the investor without fail. By purchasing shares, a person allegedly buys a pig in a poke and seriously risks his own funds, because the enterprise in which he invested can go bankrupt at any time, and the shares can depreciate.
So, a bond is a security that certifies the relationship of the creditor (investor) with the borrower in the form of a legal entity (issuer). It should be understood that the bond not only provides a guarantee for the payment of the money that the investor invested in the company, but also provides additional interest, called coupons (if, of course, we are talking about coupon bonds). Depending on the established policy of the company, coupons can be paid once a month, quarter or even year.
Ways to pay income
It is worthwhile for a novice investor to understand that the bond yield formula will not be the same in all cases, since there are different ways to pay money to borrowers. The list below shows only the main ones:
- A fixed interest payment is the most common option.
- Stepped interest rate - interest increases significantly over time.
- Floating interest income rate - interest floats from season to season.
- Nominal value indexing - payment of bond value.
- Sale of bonds at a discount - sale of securities below par.
Depending on the selected form of payment, the bond yield formula will also vary. However, do not be upset in advance! This article will provide all the necessary information on how to calculate the return on investment.
Zero-Zero
Have you thought about how to find out the current yield of a bond using the formula? To get started, you need to determine the type of security that you have purchased or are about to acquire. For example, the yield formula for a coupon-less bond is extremely simple, and even a novice investor can understand it.
Suppose a certain company sells securities at 800 rubles apiece, but their nominal value is 1000 rubles. Such a move is called selling discounted bonds. The investor will receive an income of 200 rubles from each paper when the time comes and it can be sold at face value.
Coupon yield
What does the coupon bond yield formula look like? Everything is very simple. Coupon yield is the percentage rate that the issuer pays to its borrower in a certain period. Most often, payments are made once a quarter, however, some companies may issue such securities, coupons from which can be cashed only once every six months or even a year. Although the interest rate on such bonds is usually a little higher.
A small example will help you understand the essence of payments according to the current bond yield formula:
- Annual income = Denomination x Profitability x Quantity.
The face value of the bond is one thousand rubles, and the coupon yield is 8 percent. An investor can use four coupons per year. That is, the yield on the security will be 80 rubles per quarter and 320 rubles per year. How did this number come about? First we find 1%. To do this, you need to divide 1000 by 100. After that, we multiply one percent by 8 (we find 8% - the yield of one coupon) and multiply the resulting number by 4 coupons. This is what the coupon bond yield formula looks like. Everything is very simple and clear.
Current yield
In order to calculate the current yield of a fixed rate bond, it is necessary to find the ratio of the periodic payment to the price at which the security was purchased. For example, coupon income is 100 rubles for six months, and the security was purchased at a nominal value of 1,000 rubles. In this case, it is necessary to divide 100 by 1000 - we get a number equal to 0.1, a pretty good indicator for a novice investor, especially if payments will continue at least 10 times in 3-4 years. In this case, the final yield will be 1000 rubles. In addition, the investor will also return the nominal value, which will be equal to the same price. So, net profit will be 100%. What business can boast the same payback in just three years?
Coupon bond yield to maturity formula
Coupon shares are securities whose profit is calculated on special coupons. It was mentioned above how to calculate the interest income from a bond. However, in order to understand the formula for calculating the yield to maturity of bonds, it is necessary to introduce another variable - the time after which the calculation with the investor will occur. For example, if the coupon yield on a bond is 250 rubles per year, and the security is designed to be used for four years, then this number must be multiplied by four - we get 1000 rubles. To this amount we also add the nominal value of the bond, for example, 1,500, and we get a number equal to 2,500. However, if the shareholder has already managed to receive 500 rubles in coupons for two years, then five hundred should be deducted from the final amount. As a result, the income repayment will be equal to two thousand.
Internal bond yield (formula)
Every professional investor knows that the internal yield from a bond is the amount that can be earned on a security without taking into account the face value. This numerical value is also sometimes converted to percent in order to more conveniently calculate the return on investment. It is also worthwhile to understand that not only coupon bonds have an internal yield. For example, you purchased a security at a discount for 900 rubles, although its face value is 1150. In this case, the internal yield will be 250 rubles for the entire period of use. As for coupons, it’s still easier with them. If the bond has an interest yield of 500 rubles per year, and payments are made within three years, then the intrinsic value will be 1,500 rubles (500 * 3). We will not even be interested in knowing the nominal value of the goods, since in this formula it is not taken into account.
Annual return
Of course, after all that has been read, determining the annual yield of a bond using the formula will not be difficult, especially if you thoroughly delved into the information that was provided earlier. As a rule, annual yield is calculated only for coupon securities. First, we look for coupon yield for one year. Let's say it is 200 rubles. However, the nominal value must also be added to this amount, having previously divided it by the number of years that the bond will serve its owner. For example, the face value of a security is 1200 rubles, and the term of operation is 5 years. It turns out that the annual yield will be equal to 440 rubles (1200/5 + 200).
Everything is much more complicated when a bond has a floating interest rate. In this case, the annual yield is the average value between the indicators obtained over several years. For example, in one year the yield amounted to 500 rubles, and in the second - 1000. In this case, the average figure will be 750 rubles, which will be the annual yield of the security. However, do not forget to add the face value of the bond before you begin to calculate the average value.
How is the bond rate calculated?
A similar question was asked at least once by any investor who decided to invest in the acquisition of these securities. It should be understood that bonds have not only face value, but also market value, which just depends on this rate. To calculate it, you must follow a certain formula. We take the market price of the paper (how much they offer for the owners in the market), divide it by the nominal value and multiply by 100%:
Suppose you purchased several securities with a face value of 500 rubles. However, after a few years, the company to which you provided a loan developed very much, and the cost of securities increased to 750 rubles. In this case, calculating the bond rate will be quite simple. We take the market value of 750 rubles as a dividend and divide it by a fixed face value of 500 rubles. We get a number equal to 1.5. It remains only to multiply this figure by 100% - it turns out that the bond rate is 150%.
Comparison of bonds with stocks
A feature of bonds is that their face value, unlike the same shares, is always at a certain level. Therefore, the investor practically does not risk his money, investing them in the purchase of bonds. However, this does not mean that cash deposits of this kind are completely safe. The company may completely go broke and stop paying coupon income, and also keep the face value to itself. Of course, if we are not talking about government bonds issued by the Ministry of Finance.
In turn, stocks are a great opportunity for a competent person to increase their capital in a short period of time. For example, you can buy the securities of some promising company, and then resell them in a few months ten times more expensive! However, such opportunities are also associated with great risk, since stocks may depreciate, even when it comes to state-owned enterprises. Although there is a certain group of companies, the contribution to which is accompanied by minimal risk. Such companies are called blue chips.
Conclusion
As you can see, the settlement formulas for bond yields help quickly and accurately determine the prospects of investing in a particular company. The information from this article should be enough for a novice investor, but if you still have any questions, it is strongly recommended that you watch a short video in which a professional investor talks about how to make money on bonds.
As you can see, a bond is a pretty good source of income, which you should definitely think about for those people who have finances but who do not like to take risks. The purchase of securities will also help protect money from inflation, and also guarantee you a return on investment, which joint stock companies (even from the blue chip category) cannot boast of. Although if you are attracted by risk and excitement, you can very well invest in the purchase of shares and live on income from dividends, which very often exceed the income from coupons.