Before buying any bond any one would like to compare two bonds and see which one will give high rate of return. There are three ways of calculating rate of return / yield on bonds current yield, yield to maturity and yield to call.
Current yield: - This methodology gives is a rough estimate because it excludes compounding interest and change in bond prices due to market. Below figure ‘Current Yield in action’ shows a simple sample of coupon rate of 8%, redemption of 100 and value of bond as 91% of the principal. So the current yield is 8.7%. Please note we have take percentage values of bond rather than actual values as it helps us compare two bonds of different actual face values.
Note :- There is no built in formulae for current yield in EXCEL.
Figure: - Current Yield in action
YTM: - The current yield methodology has a major drawback that it does not take in to account market prices, interest gains and capital gains. YTM also termed as ‘Yield to maturity’ is compound annual rate of return expected if the bond is held till maturity. In the below figure ‘Yield in action’ we have take a simple bond sample and used the ‘yield’ function. The only extra parameter in this is the bond price. We have taken the percentage of the bond price you can take the actual, but then you need to multiply the same with percentage factor. So 8.9 % is the answer which takes in to account the interest gain and capital gain in this bond example.
Figure: - Yield in action
Yield to call: - There are scenarios where the organization will like to buy back the bonds if interest rate decreases or probably the organization wants to call of the bond. Consider the below example where the maturity date is ‘4/23/2030’ but the organization called off the bond on ‘2/2/2012’. In case the bond is called off the organization is ready to pay 104% call price of the face value. We used the same yield formula only that maturity date is the call of date and redemption is the call price. So for this example in case the organization calls of the bond we will get 15.6% returns.
