7.3.16. Yield
Recall from Chapter Two that yield refers to the amount of income (dividends or interest) that an investment is expected to pay out over a period of time, most commonly a year. While returns measure the money that you have made on an investment, a yield is the money that you expect to make on an investment. We will review the several different types of yields so that you can handle exam questions that combine information on yield and returns.
Nominal yield is the percentage of the face value of a bond (the amount the bond will be redeemed at) that is paid out annually. The nominal yield is also called the coupon rate. The nominal yield and face value of the bond do not change over time.
For example, a bond that pays $70 per year and has a face value of $1,000 has a nominal yield of 7% (7% = $70 / $1,000). Relatedly, a bond with a coupon rate of 5% will pay annual interest of $50 (0.05 × $1,000 = $50).
Bonds typically have a face value of $1,000, meaning they pay out a principal of $1,000 at maturity. But a bond is often traded at either a premium (e.g., $1,100) or a discount (e.g., $980) to its face value. A bond’s current yield incorporates whether the bond was purchased at either a premium or discount and reflects this additional gain or loss. A bond that is purchased at a discount has a higher current yield th