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Yield to What?

When buying a bond, you want to know how much return you’ll get. A bond’s yield is a measure of expected return—based on its coupon, price and other factors. But understanding bond yields can be tricky. First, because bond prices fluctuate based on changes in interest rates, yields are constantly in motion. Second, there are several ways to calculate yield. Let’s look at four of them:

  1. Current yield is the most straightforward measure. It divides the bond’s annual interest payments by the price you paid for it. But unfortunately, it doesn’t tell the whole story, as it doesn’t take into account the return of principal, which happens when a bond matures, is sold or is called. For example, if you buy a $10,000 bond for the discounted price of $9,500, you’ll record a $500 gain when the bond matures—but the current yield doesn’t factor in those gains.
  2. Yield to maturity measures the annual rate of return you would receive on a bond investment—taking into consideration all interest payments, return of principal and the time value of money—were you to hold it to maturity.
  3. Yield to call measures the annual rate of return on a bond assuming that the bond is redeemed on the first (or next) call date.
  4. Yield to worst measures the lowest potential return you might get from a bond without the issuer actually defaulting. It is the lower of the yield to maturity or yield to call.

So which yield matters most? It depends on whether the bond is callable or not. For a callable bond, the yield to call or yield to worst would let you determine your lowest potential return. For a noncallable bond, yield to maturity is the most useful because, barring default, you’ll get back the principal when it matures.

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Important disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Performance may be affected by risks associated with non-diversification, including investments in specific countries or sectors. Additional risks may also include, but are not limited to, investments in foreign securities, especially emerging markets, real estate investment trusts (REITs), fixed income, small capitalization securities and commodities. Each individual investor should consider these risks carefully before investing in a particular security or strategy.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

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