## Understanding Bond Yields and Returns

Bonds are a critical part of fixed-income investment, which provides stable income and relatively low volatility compared to equities.

Bond yields and bond returns are sometimes difficult to understand for many investors. Before deciding to invest in bonds, it is crucial to comprehend these concepts and how they affect your bond investments.

**What Are Bond Yields**

Yield to bond is the anticipated interest from a bond investment, which is usually presented as a percentage of the current market price of the bond.

It shows the amount of earnings an investor can get per year on a bond investment, in proportion to the price of the bond. Knowledge of **bond yields **assists investors in determining the returns on their bond investments.

**Definition:**Yield is the interest or coupon paid by the bond issuer in a given period and expresses it as a percentage of the current market price of the bond.**Purpose:**Yields are used by investors to determine the amount of income that they are likely to earn on their bond investments in the future.**Types of Yields:**There are two primary methods of determining yields: current yield and yield to maturity (YTM), both of which give an idea of expected returns from bonds.

**Current Yield vs. Yield to Maturity (YTM)**

There are two primary ways to measure bond yields: The current yield and the yield to maturity (YTM). It is for this reason that it is necessary to understand the difference between these two in order to evaluate bond profitability.

**Current Yield**

**Definition:**Yield to current is defined as the quotient between the annual interest received from the bond and the current market price of the bond.**Formula:**Current Yield = (Annual Coupon Payment x 100) / Current Bond Price**Significance:**This yield provides a picture of the amount of income an investor is likely to make from the bond, depending on the price of the bond at a certain period.**Example:**Current yield would be determined as follows: If there is a bond with face value of $1000 that pays $50 in interest annually and it is traded at $900 then the current yield will be 5. 56%.

**Yield to Maturity (YTM)**

**Definition:**YTM is a more accurate measure of the total return on a bond if it is held till the date of its maturity. This comprises of the coupon payments and any gain/loss that may be realized from purchasing the bond at a price other than its par value.**Formula:**It is not easy to calculate the YTM, but it incorporates the bondâ€™s price, interest received, and years to maturity.**Significance:**YTM enables investors to determine the actual rate of return on a bond if they continue to own the bond till it reaches its maturity.**Example:**If a bond is bought at less than its face value, YTM will factor in the discount and thus give the total return of the bond.

**Bond Price and Yield Relationship**

There is a positive relationship between the bond price and the yield to maturity of a bond. The first principle that underlies **fixed-income investing** is the negative correlation between bond prices and yields.

In other words, as the prices of the bonds increase, the yields decrease, and when the prices of the bonds decrease, the yields increase.

**Inverse Relationship:**If there is an increase in the interest rates, new bonds are floated at higher coupon rates so that older bonds with lower coupon rates lose their appeal. Therefore, the market prices of the older bonds decline, and consequently, their yields rise.**Interest Rate Impact:**Interest rate decisions made by the central bank have a direct impact on bond yields and prices. When the rates are on the rise, the bond prices decrease and thus bond yields increase.**Bond Investment Tip:**Bonds are bought by investors, and the interest rate structure is a factor that must be put into consideration in the current market. Investing in bonds may be unprofitable especially when rates are on the rise as the value of bonds decreases.

**What Are Bond Returns**

Bond returns are the total profit or loss that one is likely to make from holding a bond. This involves both the coupon (interest) and any capital appreciation or depreciation if the bond is traded before maturity.

**Definition:**Gains on bonds include the interest income and the difference in the bond price at the time of purchase and the time of sale.**Realized vs. Unrealized Returns:**Realized gains are the gains made by an investor when he sells bonds for a profit or loss, while unrealized returns are the changes in the market value of bonds that have not yet been realized.**Importance:**In fixed-income investing for the long-term investor, understanding bond returns assists in determining whether the investment has met the expected income and growth targets.

**Effects of Interest Rates on Yield and Return of Bonds**

Interest rates are also influential in determining both bond yields and returns. When the interest rates are high, the price of bonds is low and this impacts both the yields and the **bond returns.**

**Rising Interest Rates:**

**Bond Yields Increase:**New bonds issued in a rising rate environment have a higher yield than existing bonds, making them more attractive to investors. This results in the existing bonds prices going down since they have lower interest rates than the newer bonds.**Bond Returns Decrease:**If interest rates increase, the price of existing bonds will decrease, meaning that there will be less returns on investment, particularly if the bond is sold before it reaches maturity.

**Declining Interest Rates:**

**Bond Yields Decrease:**As interest rates decline, new bond issues come to the market with lower coupons. However, the prices of existing bonds with higher coupon rates rise thus lowering their yields.**Bond Returns Increase:**Lower interest rates can translate into higher bond prices, meaning capital gains if the bond is sold. In this investment environment, investors with bonds in their possession may experience higher total returns.

**Conclusion**

It is important to distinguish between the yields of bonds and the returns from bonds when investing in fixed-income securities.

Therefore, understanding how yields are determined, how changes in interest rates influence returns, and the concepts of duration and yield spreads will help investors make better decisions.