There are two main forms of investments: stocks and bonds. Bonds represent a form of debt and the issuer of the bond pays the bondholder for the use of funds, much like a consumer pays a rate of interest to the bank on a car loan. Most bonds are offered at a premium or discount to par. Par is the face value of the bond -- it is the value of the bond at redemption. A bond selling at par is not selling at premium or discount, which makes finding the return on investment or the yield much easier.
Identify the cost of the bond -- the price paid. If the bond is selling at a premium it will sell above par. If the bond is selling at a discount, it will sell below par. However, if the bond is purchased at par, it means it is selling for face value. This is also referred to as the redemption value on the bond term sheet and prospectus. These are two full disclosure documents required by the Securities and Exchange Commission from public companies before they can issue bonds to the public. In this example, assume the bond's par value is $1,000.
Find the semi-annual payment paid to bondholders. Different bonds pay different amounts depending on the risk profile of the issuing company. A riskier company pays a higher amount and vice versa. Assume the semi-annual bond payment is $40, or $80 a year.
Divide the annual bond payment by the par value. For this example, the calculation is $80 divided by $1,000, or 8 percent.
Tips & Warnings
- If the bond sold at a premium, the premium is deducted from the yield to maturity over time. Likewise, if the bond sold at a discount, the discount is added to the yield to maturity over time. In this way, all other things being equal, a bond selling at a premium is worth less than a bond selling at a discount.
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