How to Calculate Profit on a Bond

How to Calculate Profit on a Bond
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Bonds are long-term investments. You would typically buy a bond with the intention of holding on to it for numerous years while it earns interest.

Bonds can be issued by any federal government or agency or by a corporation or other organization to raise working capital. Bondholders effectively loan the issuer money when they purchase a bond, and the issuer eventually returns their money to them when the bond reaches maturity. It pays them annual interest payments or semiannual interest payments as well. Interest on U.S. Treasury bonds is paid semiannually, according to TreasuryDirect.

How to Calculate Profit or Loss on a Bond

The simplest way to calculate bond valuation and whether you’ve earned or lost money when you redeem a bond is a matter of basic math: Subtract what you paid for the bond from the proceeds. A negative number indicates that you’ve suffered a loss. But you can go deeper to arrive at more detailed information with the following formula:

  • Multiply the face value of the bond by the market interest rate you’re receiving. The bond’s face value is what the issuer of the bond has agreed to pay you when the bond matures. It’s not necessarily the present value of a bond. You might also hear it referred to as the “par value.” This calculation will tell you how much interest the bond is paying you each year.
  • Now, multiply that figure by the years that remain until the bond’s maturity. This is the total amount of interest you can expect to collect over the life of the bond.
  • Subtract the price of a bond from its face/par value and add in the total interest it will earn.

The result will be just the interest if you paid face/par value. Add the amount to your interest if you paid less than face/par value or subtract it if you paid more. This is your total profit or loss on the bond.

Understanding Yield

Your yield on a bond is how much money it has earned (or lost) after you’ve done the math. But there are different types of yield to consider:

  • Coupon yield:‌ This is the rate of interest you’re guaranteed at the time of purchase. It’s also referred to as the coupon rate. FINRA indicates that it will not change over the life of the bond.
  • Current yield:‌ Divide the coupon yield or yearly coupon payment by the bond’s current market price. This yield will change along with the market price. The current yield will rise when and if the price of the bond drops. Current yield comes into play if you decide to sell your bond before the maturity date.
  • Yield to call:‌ This is your interest rate if the issuer “calls” the bond or pays it off before maturity. It assumes that you’re not collecting interest payments on the bond all along but rather reinvesting the interest earned, effectively leaving it with the bond issuer.
  • Yield to maturity:‌ This is the interest rate you’ll earn if you hold the bond to maturity. It’s calculated as an annual rate of return. It’s the discount rate at the time that future cash flows from the bond equal the price of the bond.
  • Yield to worst:‌ The lesser of the yield to call or the yield to maturity is the bond’s yield to worst. As the name implies, it’s a worst-case scenario. This is the least you can expect to profit from your bond purchase.

FINRA cautions that yield to call and yield to maturity are estimates at best.

How to Read a Yield Curve

In most basic terms, yield is the annual percentage rate you earn on a bond, according to FINRA. A yield curve is a graph that memorializes a bond’s data at given points in time as compared to other bonds of the same quality.

Look for the interest rate in the vertical columns of the graph and the bond’s maturity on the horizontal lines. The curve maps the increases and decreases brought about by changes in the daily interest rates, according to the Federal Reserve Bank of San Francisco.

The curve usually slopes up because yield tends to increase when a bond is held for a longer time.

Understanding Return

Your return is the total money you earn or lose when you invest in a bond, often expressed as a percentage.

FINRA indicates that you can arrive at it by adding your coupon earnings and interest to the value of a bond when it reaches maturity. Now, subtract your costs incurred in purchasing and holding the bond, such as commissions, fees and any taxes that will result from redeeming it. You’ll arrive at a percentage if you divide your return by the bond’s beginning value and then multiply this by 100.

A bond’s annual percent return is simply the percent return divided by the number of years you owned or held it. You can calculate your real return by subtracting the current inflation rate from your percent return.

Two Kinds of Bond Redemptions

The bottom line to all these calculations is your timing in redeeming your bond. You basically have two choices.

Most bonds have a maturity date that’s determined at the time the bond is issued to you. The issuer will pay to you the principal payment or face/par value of the bond at this time plus the interest due to you to date. Bonds can mature at one year, at five years or at more than 10 years.

Issuers can retain the right to retire a bond and pay you before the maturity date. This arrangement is referred to as a callable bond.

You can hold your bond until the maturity date or the date it’s called, or you can redeem it earlier at any time.

Common Questions About the Current Value of a Bond

How Do I Find the Current Price/Present Value of a Savings Bond?

TreasuryDirect provides a calculator on its website to assist you in determining a savings bond’s current value. Just enter its denomination, its issue date, and the type of bond you hold. The issue date and its serial number (determining its type) can be found on the bond itself.

How Do I Calculate a Bond’s Interest?

The TreasuryDirect calculator will also tell you the bond’s current and historical interest rates if you hold savings bonds. You can use the equations provided here for other types of bonds.

How Do I Find the Gain or Loss on a Bond Redemption?

FINRA provides its Market Data Center that details the information you’ll need to pin down your gain or loss on U.S. Treasury bonds as well as other government bonds and corporate and agency bonds. It provides numerous details on the current and historical bond market.