Hi and welcome to this week’s Question of the Week! For this week, the word ‘yield’ will be covered in the following question:
How are bond yields calculated, and why are they important?
The term yield can have different definitions, all based on the word’s context. For instance, when a person yields from a fight, it means that the person is giving up or surrendering. When on the road, some signs contain the word yield. This means that you have to give way to other cars. Yield can also stand for producing a return, as is used in bond yields. This week’s question looks at the second definition.
A bond’s yield can be calculated by dividing the interest by the current value of the bond. This is presented in the following formula:
Yield = Annual interest / Bond Price
Calculating bond yields is important as aggregating them gives you an indication of the success of a bond over time. For instance, knowing that a bond with a value of €100 yields 10% (or €10 interest) for the past 5 consecutive years is more attractive to invest in than a bond that yielded 25% in the first year, but then dropped to 5% in the 5th year.
In short: The term yield can mean to stop, give way, give-up, surrender, or be a calculation of returns in business. In a business sense, yields can be calculated by dividing the annual interest by the bond price. This would then give an indication of the returns over time of a bond, and thus its attractiveness.
If you have any questions, other examples, or doubts, then please do not hesitate to leave a comment!
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