This week’s column is going to deal with bond pricing and yields. While it may be more technical than usual, hang in there.
Pricing a bond can be somewhat arcane. However, there are several key components of a bond including its maturity date, redemption price (or maturity price), coupon (interest rate it pays) and its yield to maturity. In addition, some bonds have a call date — the date at which the issuer can redeem the bond before maturity at a price known as the call price. Issuers usually call bonds when interest rates fall substantially. They pay off older bonds (at the higher interest rate) and reissue new bonds at lower rates.
Bonds are price as a percentage of par, or face value, which generally is $1,000. Par is 100 percent, but written without the percent sign as 100. A price of 99 1/32 would equal $990.31 for each $1,000 face amount. Bond price changes usually are quoted in fractions no smaller than 1/32 point, which is $.31 per $1,000 face amount. Treasury issues are an exception, however, as their huge trading volume frequently require even smaller increments. One point equals $10 per $1,000 of bonds, corporate or treasury.
Yield, or the rate of return, is the key consideration to holders of bonds and other interest-bearing assets. The current yield is simply the rate of periodic interest divided by the bond’s price. Thus, a 10 percent bond selling at 80 has a current yield of $100 divided by $800, or 12.5 percent.
Yield to maturity is another way to measure the price of a bond. It incorporates the total annual coupon payments over the life of the bond, a purchase price, the redemption value and the time remaining until the bond matures.
Yields to maturity of different bonds are often plotted on graphs to illustrate comparative rates. This is known as the yield curve. When the plot line is ascending, which occurs when long-term rates are higher than short-term rates, there is a positive yield curve. When the plot line is descending, which occurs when long-term interest rates are lower than short-term rates, there is an inverted or negative yield curve.
Some bonds can be redeemed, or called, prior to their final maturity. Investors need to know their yield to the call date, which can be calculated in the same manner as yield to maturity.
Finally, bond prices rise when interest rates fall and fall when interest rates rise. Essentially, investors want to buy bonds paying a higher rate of interest rather than bonds paying lower rates. However, on any given day, bonds with higher rates usually carry greater risk than those with lower rates.
Quote of the week: “When all else is lost, the future still remains.” — Bovee
Bart Ward is the chief executive officer of Ward & Co. Ltd., an Anoka-based registered investment adviser – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.