What is a bond yield and how is it calculated?

Bond Prices and Yields: Understanding Their Relationship

To understand how bond yields work, consider a simple example. Suppose you purchase a bond for $10,000 that pays $225 in interest each year. In this case, the current yield of the bond would be 2.25%.

If the bond is later sold in the market for $12,000, the annual interest payment remains $225, but the yield for the new buyer changes. Since the purchase price is higher, the yield becomes lower—$225 divided by $12,000 equals approximately 1.875%.

This example highlights a key principle of bond investing: when the price of a bond rises, its yield falls, and when the price declines, the yield increases. Because of this relationship, yield often provides a clearer picture of the actual return on a bond investment than the coupon rate alone.

More advanced yield calculations may also take additional factors into account, such as the remaining time until the bond reaches maturity or any interest that has accumulated since the last coupon payment.

What Else Should You Know About Bonds?

If you want to deepen your understanding before deciding how much of your portfolio should be allocated to bonds, it can be helpful to explore additional educational resources covering bond markets, risks, and investment strategies.