THE BEECHMONT CREST ONLINE GUIDE TO STOCKS AND INVESTING
Bond Terminology
Here is a cheat sheet of some of the terminology you will need to be familiar with when talking about bonds:
Coupon Yield:
The interest rate indicated on the face of the bond: 5.75%, 6.25%, etc. The coupon yield is determined by the corporation that issues the bond. Corporations determine the coupon yields for their bonds based on market interest rates at the time when the bond is issued.
Discount Yield:
Discount yields are used for short-term bonds like Treasury bills. The discount yield is a percentage of par value adjusted to an annual rate. This is the percentage at which the bond sells.
For example: If a Treasury bill sells at a 7% yield, it sells at 93, or $930. The discount yield is 7 divided by 93, or 8%.
Current Yield:
The current yield is the bond’s annual interest payment versus the bond’s current market price.
For example: Suppose that a bond with a coupon yield of 7% is selling at $800 ($200 below its issue price of $1000.)
Divide the annual interest payment ($70) by the current bond price of $800 and multiply by 100. The result is 8.75%, the current yield.
Yield to Maturity (YTM):
You can calculate the YTM of a bond as follows. (For the sake of simplicity, let’s continue with the same bond we considered in the Current Yield explanation above:
1. First subtract the current price of the bond from its face value:
$1000 - $800 = $200
2. Then divide the result by the number of years left until the bond matures. (In this case, we will say that the bond matures in 5 years.)
$200 / 5 = 40
3. Then add that number to the annual interest payment:
40 + 70 = 110
4. Add the current price to the face value and divide the sum by 2:
1000 + 800 = 1800
1800 / 2 = 900
5. Divide the result of step 3 by the result of step 4:
110 / 900 = 12%
This is the YTM of the bond.
