Bonds can trade at a premium or discount to the face or maturity value. Once a bond is issued, it pays a fixed amount of interest, called the coupon rate. Premium and discount prices are how the bond market adjusts current bond yields to the coupon rate paid by the bond. To calculate the current yield and yield to maturity--YTM--of a bond, you need the bond price, the coupon rate of interest, and number of years until the bond matures.
Multiply the quoted bond price times the face or par value of the bond, and divide by 100. Bond prices are quoted as a percentage of par value, such as 98.375 or 103.260. For example, using this discount price on a $10,000 bond, multiply 98.375 times 10,000 divided by 100, resulting in a bond market value of $9,837.50.
Multiply the bond coupon rate times the bond face value to get the annual interest payment. If the coupon rate is 6 percent, multiply 0.06 times our $10,000 bond, resulting in $600 in annual interest paid by the bond.
When multiplying with percentages, always convert to a decimal first. Examples: In decimal form, 6 percent is 0.06, 25 percent is 0.25 and 110 percent is 1.10.
Divide the annual interest payment by the current market value and multiply by 100 to calculate the bond's current yield. Using our example, 600 is divided by 9,837.5 times 100 providing a bond current yield of 6.099 percent.
Use a yield-to-maturity calculator (see Resources section) to determine the bond's YTM. Our practice bond has 10 years to maturity. Enter the figures from the previous steps for current price, par value, coupon rate and years to maturity. Click on calculate. The yield to maturity is 6.223 percent.
For a discount bond, the current yield will be higher than the coupon rate and the YTM will be higher than the current yield.
For a premium bond, the current yield will be lower than the coupon rate and the YTM will be lower than the current yield.
The yield to maturity is the rate of return an investor receives if the bond is held until it matures. YTM should be used to compare the relative return of different bonds.
- For a discount bond, the current yield will be higher than the coupon rate and the YTM will be higher than the current yield.
- For a premium bond, the current yield will be lower than the coupon rate and the YTM will be lower than the current yield.
- The yield to maturity is the rate of return an investor receives if the bond is held until it matures. YTM should be used to compare the relative return of different bonds.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.