It’s tempting to put all of your money into high-risk investments that promise big profits. But if you’re smart, you’ll balance high-risk investments with something safer like bonds. When you own bonds, it means the issuing company or government owes you money. Until the bond matures, you get paid interest. For most bonds, this means you get a nice interest payment, usually twice a year. The interest payment stays the same for the life of the bond. Some bonds work differently. With zero-coupon bonds, you still get interest payments, but the money gets added to the bond, increasing its value and the size of each succeeding interest payment.
Calculate Periodic Interest Payments
Compute the periodic interest rate of the bond. Interest on bonds is usually calculated twice per year. Once you know how many times each year interest is calculated, divide that number into the annual interest rate to find the periodic interest rate. For example, if a bond pays 8 percent in two semiannual installments, the periodic rate is 4 percent.
Multiply the periodic interest rate by the face value for bonds that pay the interest directly to you. For example, if a corporate bond has a face value of $1,000 and the periodic rate is 4 percent, you have $1,000 * 0.04, which equals $40. This is the amount of the interest payment you’ll get every six months.
Determine Interest Earned
Find the original price of a zero-coupon bond. Zero-coupon bonds are sold at a discount off the face value. The usual practice is to set the price so that accrued interest will bring the bond’s value up to the face value when the bond matures. The discount rate will be stated on the bond.
Multiply the initial price of the zero-coupon bond by the periodic interest rate and add the result to the original price to find the value of the bond after the first interest-earning period, called a compounding interval. Suppose a zero-coupon bond with a face value of $1,000 is sold for $500 when issued and earns 8 percent interest compounded semiannually. The periodic rate is 4 percent and the interest earned is 4 percent of $500, or $20. The interest is added to the value of the bond, making it worth $520 after the first six-month compounding interval.
Apply to Other Compounding Intervals
Repeat the above for each subsequent compounding interval, using the value of the bond at the end of the previous compounding interval. For the bond with the 4 percent periodic rate, the interest would be 4 percent of $520, or $20.80. This interest payment is added to the bond, bring the value to $540.80.
If you know the current value of a zero-coupon bond, you can skip calculating the interest payments that have accrued since the bond was issued. Current value is the value of the bond at the end of the most recent compounding period. Just multiply that current value by the periodic interest rate to calculate the interest payment. Interest payments on US Series EE and Series I savings bonds are calculated like zero coupon bonds, with two exceptions. “Electronic” savings bonds sold online are sold at face value, not at a discount. Series I bond interest rates are adjusted each May and November to compensate for inflation, so you need to look on the Treasury Direct website to find the current periodic interest rate before calculating the interest payment.
