If you play the stock market, you probably want to win. You hope to get a small return on your money, or at least to get it back. Your choice of investment is very important, so knowing how much money you can expect to make is very helpful. The most general definition of yield is the amount of money returned (usually once a year) in the form of dividends.
In finance, a bond is a debt security in which the issuer owes the holders a debt and is required to pay back the principal and interest (the coupon). Other rules may also be attached to the bond issue, such as the issuer having to give the bond holder certain information or the issuer having to act in a certain way. Most bonds have a fixed term (called the maturity) that is longer than one year.
A bond is just a loan that comes in the form of a security. The terms are different, though. The person who buys the bond is like the person who lends the money, and the coupon is like the interest. Bonds allow the issuer to use money from outside the country to pay for long-term investments.
- Current Yeild
If you want to figure out how much money you stand to win, the process is actually very easy. Divide the amount of interest paid each year by the current price on the market. CY = IAP*100. (Adding 100 to the fraction makes it a percentage.) For example, a bond with a face value (par) of $1000 and an interest rate (coupon) of 7% that matures in 10 years might sell at a discount for $950 right now.
Keeping your connection to maturity
If you keep your bond until it matures, you will get the most money in dividends. Would you rather have $1,000 now or $1,000 in a year, even if you know you'll get paid in a year? If you get your $1000 sooner rather than later, you can earn interest on it for an extra year.
- Age at Maturity
When comparing bonds with different rates and dates of maturity, YTM is the best number to use. With a little practise, the process becomes second nature and loses its mysterious feel. Profits go to those who don't worry. Here's how it works...
c(1 + YTM)-1 + c(1 + YTM)-2 + . . . + c(1 + YTM)
-YUM + B(1 + YTM)
-YUM = P
c = annual coupon payment (in dollars, not a percentage)
YUM = the number of years until maturity
B = par value (original issue price)
P = price to buy
