# Relationship Between Bond Price & Yield to Maturity

Investors generally buy bonds for two reasons. The first reason is to receive regular interest payments. The second is to get back their principal when a bond matures. What many investors may not understand is how the amount they pay for a bond affects its overall return, or yield to maturity. The simple answer is the lower the price you pay for a bond, the higher the yield to maturity will be.

## Bond Pricing

The face value (also known as the par value) of most bonds is \$1,000. However, the market value of a bond – what you pay for it – varies from day to day and even from minute to minute. Like stocks, bonds are publicly traded securities, meaning their price can move based on a number of factors. One of the most important determinants of a bond's price is the level of current market interest rates. When interest rates rise, bond prices fall, and vice versa. Thus, you shouldn't expect to pay exactly \$1,000 for every bond you buy, and this is an important concept to understand when calculating yield to maturity.

## Bond Yield to Maturity

When you buy a bond, the issuer promises to repay the face value of the bond at maturity. If a bond has a face value of \$1,000 and you pay \$1,000 to buy the bond, your yield to maturity will be the same as the interest rate of the bond. However, if you pay less than \$1,000 for that bond, your yield to maturity will be higher. Say, for example, you pay \$900 for a bond with a face value of \$1,000. In addition to the regular interest payments you receive, you'll also generate a gain of \$100 at maturity. This represents an increase in the yield to maturity over the stated interest rate of the bond.

## Bonds and Interest Rates

Bond prices go down when interest rates rise because investors will always seek out the highest rates. If you buy a bond that pays 5 percent interest and market rates go up to 8 percent, investors will sell the bond because it isn't worth as much as the newly issued 8 percent bonds. Prices will trend down until the yields become equivalent. The opposite is also true. If you hold a 5 percent bond and rates trend down to 3 percent, investors will pay more for your bond, as it's better to receive 5 percent in interest than 3 percent.