Bond Analysis in Relation to Bond Yield

Investors perform bond analysis for one thing and one thing only - to determine if the bond will yield a desirable rate of return on investment within the set timeframe. In short, bond fundamental analysis results in a figure representing the bond yield. This is not surprising considering that investors in any kind of market security, whether it is a share of stock or a certificate of bond, want to earn the maximum profit from the investment. The higher the bond yield, the better for the investment portfolio.

Before we segue into the computations for bond yield, it must first be noted that there are many factors to be considered in bond analysis. These factors include the fundamentals of price-earnings ratios, price/earnings to growth ratio, and dividend payments as well as technological changes, inflation and interest rates, and credit risk. These factors are discussed in other related articles.

For this article, the bond fundamental analysis will focus on yield calculations and yield curves.

Bond Analysis - Yield Calculations

The current yield is the simplest and often the most used of all yield calculations. The formula is simple:

Current Yield = annual coupon amount paid/current price

For example, if a $1000 bond is offered with a 7% coupon rate and selling at a discount of $950, the current yield is computed as follows:

CY = [($1000 x .07)/950]
= 70/950
= 7.37%.

This means that the current yield for the bond is greater than its coupon rate.

If you have the hang of bond analysis, you will want to go for advanced computations including the Yield to Maturity formula. Admittedly, the mathematical formula is daunting although we must say that it involves capital gains or losses. In the above example, the yield until the bond matures is at 8.53%.

Other more sophisticated calculations of bond yield include Macaulay Duration and Convexity. Don't worry about being a genius mathematician - that's where online calculators come in.

Bond Analysis - Yield Curves

If you want to see how bond yield behaves over time, you should learn to make useful graphs. These are called Yield Curves wherein the yield is compared to maturity - yield is plotted vertically while maturity is plotted on the horizontal axis. Thus, you are able to compare yields for bonds with different maturities, which is very useful when you have many bonds to choose from such as from corporate and government issues.

In bond analysis, the normal yield curve has a gentle rise that then tapers off to a flat line. If the rise is steep and then takes longer to flatten at the end, it is known as the steep yield curve.

An inverted yield curve refers to a bowl-shaped curve wherein the rates are higher on the short-term bonds than on the long-term bonds. In this case, the investors are compensated for the increased risks of a lengthy maturity period or the increased risks for default through higher interest rates.

Indeed, patience in computing for the bond yield and in analyzing the yield curve results in better investment decisions. So, learn to perform intuitive bond analysis and earn maximum profits.