To understand what the bond rate depends on is not so easy. For many beginning investors, it becomes a revelation that the rate of bonds is changing every day, like any other securities traded on the stock exchange.
Yield is a measure of the profit you receive from a bond. The easiest way to calculate the yield is according to the following formula: yield = number of coupons/price. If you bought a bond at par, the yield is equal to the coupon rate. When the course changes, the yield also changes.
Example If you bought a bond with a 10 percent coupon rate at par value of $ 1000, the yield is 10% ($ 100 / $ 1000). Easy peasy. But if the price of a bond fell to $ 800, then its yield rises to 12.5%. This is because you get your guaranteed $ 100 for an asset whose value is $ 800 ($ 100 / $ 800). Conversely, if the price of the bond rose to 1.2 thousand dollars, its yield fell to 8.33% ($ 100 / $ 1200).
Of course, in reality, things are even more confusing. When investors talk about returns, they usually mean yield to maturity (YTM). YTM is a more complex indicator that shows the investor’s profit if he keeps the bond until maturity. It takes into account all coupon payments that you receive (and assumes that you reinvest the coupon payment at a rate equal to the current yield of the bond), as well as profit if you bought a bond at a discount, and loss if the purchase price was above par.
The formula for calculating YTM does not interest us right now. These are quite complex calculations that go beyond our learning text. Here it is important to remember that YTM is a more accurate indicator, and allows you to compare bonds with different redemption conditions and coupons.
The ratio between the price of a bond and its yield can be formulated so when the price rises, the yield drops, and vice versa. In other words, it can be said that the price of a bond and its yield are inversely proportional.
A popular question is which is better, high price or high bond yield? The answer depends on your point of view. If you buy a bond, you need a high yield. The buyer wants to pay $ 800 per share, priced at $ 1,000, which means a yield of 12.5%. On the other hand, if you already have a bond, your coupon rate is fixed and you hope that the price of the bond will grow. Then you can get the benefit by selling it in the future.
Now you know what face value, coupon, redemption, issuer, and yield are. All these characteristics of a bond play a role in determining the price of a bond. However, it is even more affected by the overall level of prevailing interest rates.
When interest rates rise, the bond rate in the market falls, increasing the yield of previously issued bonds and equalizing them with new bonds with higher coupon payments. When interest rates fall, the rate of bonds in the market rises, lowering the yield of previously issued bonds and equalizing them with new ones. bonds with less high coupon payments.