Bond Yield

Bond yield is the effective return you earn from a bond investment. Unlike stocks (where return comes from price appreciation), bonds pay fixed interest (coupon payments) and return your principal at maturity.

Types of Bond Yields:

1. Coupon Rate (Nominal Yield) The fixed interest rate printed on the bond

Example:

• $1,000 bond with 5% coupon
• Pays $50/year (regardless of market price)
• Coupon rate: 5.00%

2. Current Yield Annual interest divided by current market price

Formula: Current Yield = Annual Interest ÷ Current Price

Example:

• $1,000 bond, 5% coupon ($50/year)
• Trading at $950 (below par)
• Current yield = $50 ÷ $950 = 5.26%

**3. Yield to Maturity (YTM)

• Most Important** Total return if you hold bond until maturity (includes coupon payments + gain/loss from price difference)

Example:

• $1,000 bond, 5% coupon, 10 years remaining
• Current price: $950
• YTM = 5.68% (higher than coupon because buying below par)

How Bond Prices and Yields Relate:

Inverse Relationship:

• Bond price ↑ → Yield ↓
• Bond price ↓ → Yield ↑

Example: $1,000 bond with $50 annual coupon (5% coupon rate)

Bond Price	Current Yield	Status
$1,100	$50 ÷ $1,100 = 4.55%	Trading at premium
$1,000	$50 ÷ $1,000 = 5.00%	Trading at par
$900	$50 ÷ $900 = 5.56%	Trading at discount

Why Bond Prices Change:

Interest Rates Rise:

• New bonds offer higher coupons
• Your old bond less attractive
• Price falls, yield rises to compete

Interest Rates Fall:

• New bonds offer lower coupons
• Your old bond more attractive
• Price rises, yield falls

Real Example (2022-2024): 2020-2021: Fed rates near 0%, 10-year Treasury yields ~1.5% 2022-2023: Fed raises rates to 5.25%, 10-year Treasury yields rise to 4.5% Result: Bond prices fell 10-20% (yields rose)

Yield Curves:

Normal Yield Curve:

• Longer bonds = higher yields
• 2-year Treasury: 3.5%
• 10-year Treasury: 4.2%
• 30-year Treasury: 4.5%

Inverted Yield Curve:

• Short-term yields > long-term yields
• 2-year: 5.0%
• 10-year: 4.3%
• Recession indicator (has predicted last 7 recessions)

Flat Yield Curve:

• Similar yields across maturities
• Transition period (economy uncertain)

Yield Spread: Difference between two bond yields

Common Spreads:

• Credit spread: Corporate bond yield
• Treasury yield (risk premium)
• Term spread: 10-year yield - 2-year yield (yield curve slope)

Example:

• 10-year Treasury: 4.0%
• 10-year Corporate (AA): 5.2%
• Credit spread: 1.2% (extra yield for credit risk)

Factors Affecting Bond Yields:

1. Interest Rates (Fed Policy) Biggest driver

• Fed raises rates → bond yields rise

2. Inflation Higher inflation → higher yields demanded (compensation for purchasing power loss)

3. Credit Quality Lower credit rating → higher yield (risk premium)

Bond Type	Typical Yield (2024)
10-year Treasury	4.0% (safest)
AAA Corporate	4.8%
BBB Corporate	5.5%
Junk Bond (BB)	7.5%+

4. Time to Maturity Longer maturity → higher yield (usually)

5. Supply and Demand More buyers → price up → yield down

Tax Equivalent Yield: For municipal bonds (tax-free):

Formula: Tax-Equivalent Yield = Municipal Yield ÷ (1

• Tax Rate)

Example:

• Municipal bond: 3.5% tax-free
• Your tax bracket: 24%
• Tax-equivalent yield = 3.5% ÷ (1 - 0.24) = 4.61%

A 3.5% muni bond equals a 4.61% taxable bond for you.

**Callable Bonds

• Yield to Call:** If bond can be "called" (redeemed early by issuer):

Yield to Call (YTC): Return if bond called at earliest date

Example:

• $1,000 bond, 6% coupon
• Callable in 5 years at $1,050
• Current price: $1,080
• YTC might be 4.5% (vs 5.2% YTM)
• If rates fall, issuer likely calls bond (bad for you
• lose high yield)

Duration and Interest Rate Risk:

Duration: Measure of bond's sensitivity to interest rate changes

Rule of Thumb: If interest rates rise 1%, bond with 7-year duration falls ~7%

Example:

• Bond duration: 8 years
• Interest rates rise 0.5%
• Bond price falls ~4% (8 × 0.5%)

Longer duration = more interest rate risk

Using Bonds in Your Portfolio:

Young Investors (20s-40s):

• 10-30% bonds (stability)
• Focus on total return (stocks for growth)

Middle Age (40s-60s):

• 30-50% bonds (balance)
• Shift toward income and stability

Retirees (60s+):

• 40-60% bonds (income + safety)
• Live off bond interest + dividends

Common Bond Strategies:

1. Bond Ladder: Buy bonds maturing in different years

• 2026, 2028, 2030, 2032, 2034
• Reduces interest rate risk
• Steady income stream

2. Barbell Strategy:

• 50% short-term bonds (1-3 years)
• 50% long-term bonds (15-30 years)
• Skips middle maturities

3. Total Bond Market Index:

• Own thousands of bonds via one fund
• Instant diversification
• Low cost (0.03-0.05% expense ratio)

The Bottom Line: Bond yields represent your expected return from bond investments. Higher yields mean higher returns but also higher risk (credit risk, interest rate risk). The key is matching bond duration and credit quality to your risk tolerance and time horizon.