The starting point for calculating the return on a bond is the nominal yield. Many bonds make periodic interest payments over the life of the bond and then reimburse the investor for the face value when the bond matures. The nominal yield of a bond measures the percentage of the bond’s face value that the issuer pays to investors in interest each year. The higher the nominal yield, the larger the portion of the bond’s face value that you will receive each year in interest. However, nominal yield isn’t the only thing to consider when determining if a particular bond is a good buy for you.
Calculating the Nominal Yield
To calculate the nominal yield for a bond, add up all of the bond payments made during the year. If a bond makes only one annual payment, that’s it. However, if a bond makes multiple interest payments, such as semiannual payments or quarterly payments, you must add up all of those payments. Then, divide the total of the annual interest payments by the face value of the bond to find the nominal yield as a decimal. Finally, multiply the nominal yield as a decimal by 100 to find the nominal yield as a percentage.
For example, say a bond with a face value of $1,000 makes $15 quarterly interest payments. First, multiply $15 by 4 for the four quarterly payments to find that the total annual interest payments equal $60. Second, divide the $60 of annual interest payments by the $1,000 face value to find that nominal yield as a decimal equals 0.06. Finally, multiply 0.06 by 100 to find that the annual nominal yield equals 6 percent.
Don’t Forget Premium or Discount
The nominal yield isn’t the only thing to consider when determining whether a bond is a good investment. Just because a bond has a given face value doesn’t mean that is the price that you will pay to purchase it. If the bond is in high demand, you may have to pay more than the face value for the bond. In that case, your actual yield will be lower than the nominal yield because you paid a premium for the bond. However, if you can purchase the bond at a discount that is less than the face value, your actual yield will be higher than the nominal yield. For example, if a bond has a nominal yield of 6 percent, but you can purchase it below the face value, your actual return will be higher than 6 percent.
- The par value is not linked to how much you paid for the bond. For example, a bond with a face value of $2,000 could be traded for $1,900 or $2,100 depending on market conditions.
- The nominal yield does not account for interest compounding or how long it will take you to have your original investment repaid when the bond matures.
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