One key aspect of any bond investment is its current yield. When a bond is brand new, figuring out the yield is relatively simple because, in most cases, bonds are issued at prices that are close to what investors will receive when they mature, also known as the bond's par value. When a bond's price is close to its par value, the bond yield is close to its coupon rate. Yet, as interest rates in the broader bond market change, bond prices can rise or fall dramatically from their par value, and that makes calculating yields trickier.
The simple calculation
The simple but imprecise way to calculate semi-annual bond yields
To get an initial approximation of a semi-annual bond yield, one simple method is simply to take the coupon rate on the bond to calculate the semi-annual bond payment and then divide it by the current price of the bond to get a yield. Coupon rates are quoted in terms of annual interest payments, so you'll need to divide the rate by two in order to figure out the semi-annual payment.
For instance, say you own a bond with a par value of $1,000 whose current price is $900. Its coupon rate is 2%, and it matures five years from now. To calculate the semi-annual bond payment, take 2% of the par value of $1,000, or $20, and divide it by two. The bond, therefore, pays $10 semiannually. Divide $10 by $900, and you get a semi-annual bond yield of 1.1%.
Why simple isn't best
Why the simple method isn't the best one
The problem with using the simple method to calculate semi-annual bond yields is that it ignores the impact of gains or losses between now and when the bond matures. For instance, in the example above, an investor who bought the bond for $900 would get $10 semi-annual interest payments for five years but would then get $1,000 at maturity -- adding another $100 to the total return on the bond.
One way to take gain or loss into account is to divide it up across the remaining periods and then add or subtract it from the interest payment. Again, using the example above, with five years to go, the investor will receive 10 semi-annual payments, so dividing the $100 gain by 10 gives $10 in gain per payment. Add that to the $10 in interest, and you get $20, and that works out to a yield of 2.2%, or $20 divided by $900.
Strictly speaking, dividing the gain into equal payments doesn't match up with the way that compound returns work, so if you run the situation through a financial calculator, you'll get a slightly different answer. In the case above, the actual semi-annual bond yield is 2.12%. Nevertheless, you can see that the quick equal-payment method gets you fairly close to the real answer.
Related investing topics
Related investing topics
Finally, keep one thing in mind: in most cases, bond yields are expressed in terms of annual yield, even though payments are made semi-annually. Regardless of how they're stated, though, knowing the bond yield can help you compare different bonds to find the best choices for your financial needs.
For many investment options, both stocks and bond funds, you'll need a brokerage account. The Fool has a helpful section that will let you compare various brokers' offerings and find one that's right for you.
