Frequently Asked Questions
Below you will find answers to the most common questions regarding bond yields, pricing, and fixed-income investments.
1. What is a bond yield?
A bond yield is the amount of return an investor realizes on a bond. It is expressed as an annual percentage rate. While the coupon rate is fixed, the yield fluctuates based on the bond's current market price.
2. How is Yield to Maturity (YTM) different from Current Yield?
Current Yield only considers the annual coupon payment relative to the current market price. Yield to Maturity (YTM) is a more comprehensive measure that accounts for the total return anticipated on a bond if it is held until its maturity date, including any capital gains or losses.
3. What does 'Yield to Call' mean?
Yield to Call (YTC) is the return an investor receives if the bond is 'called' (redeemed) by the issuer before its actual maturity date. This typically happens when interest rates fall and the issuer wants to refinance their debt at a lower rate.
4. How do interest rates affect bond prices?
Bond prices and interest rates have an inverse relationship. When market interest rates rise, existing bonds with lower coupon rates become less attractive, causing their prices to fall. Conversely, when rates fall, existing bond prices rise.
5. What is the difference between nominal yield and real yield?
Nominal yield is the stated return on the bond before adjusting for inflation. Real yield subtracts the expected inflation rate from the nominal yield to show the true increase in purchasing power.
6. Are bond yields guaranteed?
No. While the coupon payments and face value are promised by the issuer, the actual yield you realize depends on the price you pay for the bond and whether the issuer defaults. U.S. Treasury bonds are generally considered risk-free, while corporate bonds carry default risk.
7. How are bond yields taxed?
Taxation depends on the type of bond. Corporate bond interest is typically fully taxable at the federal and state levels. U.S. Treasury bonds are subject to federal tax but exempt from state and local taxes. Municipal bonds are often exempt from federal taxes and sometimes state taxes.
8. What is a bond's face value (par value)?
The face value, or par value, is the amount the bond issuer promises to pay back to the bondholder at maturity. For most corporate bonds, this is $1,000.
9. Why do bond prices fluctuate before maturity?
Bond prices fluctuate on the secondary market due to changes in prevailing interest rates, the creditworthiness of the issuer, and the time remaining until maturity.
10. What is a junk bond and why is its yield higher?
A 'junk bond' (or high-yield bond) is a bond rated below investment grade by credit rating agencies. Because there is a higher risk that the issuer might default, these bonds must offer higher yields to attract investors.