Muni Bond Yield

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Learning to calculate a bonds rate of return or yield starts with understanding the different rate indicators involved. Bond yields are based on the coupon rate, the price paid and the maturity length of the investment.
The 3 key interest indicators are: Nominal Yield, Current Yield, and Yield to Maturity.

Nominal

The Nominal rate or coupon rate is the fixed interest rate on the bond. This is the rate that the issuer pays to par value. It is fixed, it never changes and it is only paid to par. Par is the amount of bonds you own. This yield may or may not be your total net rate of return. If the bond was purchased at a premium (above par), then your overall yield to maturity will be lower than your stated coupon rate.

If a bond has a 7% nominal yield or coupon and was purchased at a premium of $103 ($1030), then your YTM will calculate lower because the 7% interest is only paid to the $1000 par. The $30 premium does not earn interest and is not redeemable at par. So, a 7% bond at a premium is not really "yielding" 7% in that example.

A bond purchased at a discount will have the reverse affect on yield. The Yield to maturity would be higher for a discount bond, based on the fact that you are still earning interest on par even if you paid under par. The overall YTM will calculate higher for a bond.

Yield To Maturity

The most important rate of return indicator is a bond's yield to maturity. The YTM factors in everything to give the true overall yield to an investor.

It examines the nominal yield, current yield and years to maturity. The overall rate of return can be effected by the length of time the bond is held. If a 4 point premium was paid on an 8% bond, but the bond has a maturity of 15 years, that yield will be different than if the bond was only good for 2 years.

How to calculate yield to maturity:

This is done by using the key components of a bond: the coupon rate, the price and the years to maturity. A 5% bond priced at $850 and maturing in 15 years would calculate as follows:

Yearly Coupon Interest = $50 (5% paid to $1000)
Total Discount = $150 ($100 par - cost of $850)
Annual Discount = $10 ($150 total discount divided by 15 years)
Average price - $925 (difference between $850 and $1000 par)

Add the $10 annual discount to the coupon payment of $50. This gives you $60, which is divided by $925 and that will give you the yield to maturity of this bond - 6.49%

American Investment Training