Investing in bonds 101: The ins and outs of bond yields

Julie Brownlee, Fsp Invest, 20 Jul. 2015

Tags: bonds, bond yields, how to calculate bond yields, flat yield, gross redemption yield, yield to maturity

If you want to invest in bonds and have been doing some research, you’ll have found that bonds come with their own ‘lingo’.

Whilst the language used to describe bonds may confuse you initially, it’s all very simple once you understand some key concepts.

One thing you need to understand is what bond yields are. This is how much you can hope to make from investing in bonds.

Let’s take a closer look…

What are bonds?

Bonds are essentially loans to a company or a government. Or, to put it another way, bonds are IOUs companies and governments issue.

Bonds are debt. They give companies and governments a way to raise cash.

What makes bonds unique from many other investments is they tend to pay a fixed amount of interest each year (the coupon) until a fixed date in the future. This fixed date in the future is the redemption date or the maturity date.

On that date, the bond issuer (a company or government) has to repay the face value of the bond. For example, with RSA Retail Savings Bonds, the face value of a bond is R1,000.

The different types of bond yields

There are different types of bond yields…

Flat yield
This measures only the annual income return from a bond.

Gross redemption yield (GRY) or yield to maturity (YTM)
This measures the total return before tax of a bond, the experts at Money Week explain. This yield takes into account the annual income a bond’s paid out and any capital gain or loss come the maturity or redemption date.

For example, you buy a four year bond with a 5% coupon when it’s trading at R960.

To calculate the flat yield you take the annual R50 pay out as a percentage of the bond’s price. So this bond’s flat yield is 5.2% (R50/R960 x 100).

To calculate the GRY is more complex. (If you try to include inflation to calculate your real return, the calculation becomes even more complex.)

You take the annual income of R50, plus the R10 annual capital gain (this is because when the bond matures in four years’ time, it will pay out R1,000 when you bought it for R960).

This means the GRY is 6.25% (R60/R960 x 100).

So there you have it. The ins and outs of bond yields.

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