Bond Yield can be defined as the amount of the return that an investor or a bond holder is going to enjoy on its bonds. There are a number of different types of bond yields depending upon the types of the bonds and their calculation. The most common type of bond yield is called nominal yield. In order to calculate the bond yield with nominal yield method we need two figures, the interest paid by the bond holder and the face value of the bond. In order to acquire nominal yield the interest paid is divided by the face value of the bond. Another type of bond yield is called current yield that is calculated by dividing interest paid by the bond holder with the current market price of the bond.
The bond yield of a bond in question is inversely proportion to the price or the face value of the bond. As the price of the bond increases the bond yield decrease with the same rate according to which the face value of the bond is increasing. In order to understand this concept let’s take an example:-
Suppose an investor purchases a bond having the face value of the bond equals to $1000 and the coupon interest rate on the bond is 10 percent per annum. The yield on this bond can be calculated by dividing the interest the bond pays with the par value of the bond. This can be done as under:-
10 percent of 1000 = 100
Interest paid annually = $100
Par Value = 1000
Nominal Yield on the bond= 100/1000 =10 %
If the bond price falls from 1000 to 900 then the nominal yield would be
Nominal Yield = 100/900 = 11.1%
This shows that the investor has to pay the same amount of the interest however it will have increased yield as the par value of the bond has fallen.
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