Bond's Coupon, Price and Yield
Coupons - The interest rate that the issuer pays to the bond holders can be fixed, floating or payable upon maturity. Usually, however, it will be fixed and expressed as percentage payable on the nominal amount of the bond. In that case the holder will normally receive his interest income on a quarterly basis.
Some issuers and investors prefer the yield to be as close to the current market situation as possible. To achieve this floating rate bonds are used, in which case the variable coupon changes from time to time depending on the reference rates of interest such as rates for US Treasury bills.
Some bonds pay no regular interest at all and the whole yield is rolled up to maturity. Such bonds are termed zero-coupon bonds and are sold at a discount to par value, i.e. the investor only pays a certain part of the par value expressed as percentage of par, and the issuer redeems the bond at the par value.
Price - The price you buy bonds at depends on many factors, including the coupon, demand and supply, rating, time to maturity, etc. Newly issued bonds are usually sold at par value or close to that. If the price of a bond is above par it is called trading at a premium. If the price is below par it is called trading at a discount.
Yield - Yield is your actual income, taking account of the price you have paid for the bond and the interest you have received. There are two basic yield measures: current yield and yield to maturity. Current yield reflects the actual yield from your investment expressed in percentage per annum and depends on the price of the bond and accrued interest income.
Yield to maturity is also expressed in percentage per annum and reflects the yield you will get if you hold your bond to maturity. It is important to take these measures into consideration if your portfolio consists of various bonds with different maturity dates and different yield sizes.
Market fluctuations: how price is linked to yield
During the term of a bond its price may change depending on market situation or the issuer’s credit rating, which will affect the current yield of the bond. When interest rates rise the market price of previously issued bonds decreases, because bonds issued at a later date offer higher yield and investors tend to sell less profitable bonds to buy the ones with higher yields.
When interest rates fall the market price of previously issued bonds, on the contrary, grows, because bonds issued at a later date would offer lower yield. Therefore in case of market fluctuations the income of an investor who sells bonds before maturity can be either higher or lower than yield to maturity.
How yield is linked to maturity date
The more time there is to maturity the higher the risk that interest rates may change in the future, therefore long term bonds offer higher yield than short term bonds in order to offset the investor’s future interest rate risk.
As a rule, bond markets are closely related to the situation in the global economy or in relevant local economies.
The current market price of bonds and therefore their yield can be affected by such indicators as economic growth rate, inflation, indices of employment and a multitude of other indicators, therefore before investing your money in bonds you should seek advice from your investment manager.