Interest Rate Vs. Yield
Most corporate bonds are issued with a fixed interest rate, payable to investors on an annual basis until maturity. Yield is a term that expresses the true rate of return for investors who purchase these bonds at variable prices.
Fixed Interest Rate
Most corporate bonds carry fixed interest or “coupon” rates. Corporate bonds are initially issued in denominations of $1,000 or what is called “par value.”
Prices of Bonds May Vary
After corporate bonds are issued, they trade in the secondary market on the various major stock exchanges. The prices of the bonds fluctuate depending on the prevailing interest rate environment. When interest rates rise, the prices of bonds generally decline; when interest rates drop, the prices generally rise.
True Rate of Return
Because the interest rate on a corporate bond is fixed, yield is a more accurate measure of an investor’s true rate of return when he purchases a corporate bond in the secondary market at a price either above or below its par value.
Below Par Yield
A bond purchased below its par value is expressed as a percentage of the original $1,000 face amount. For example, a $1,000 bond, purchased for $870, sells at 87% of its par value. The yield on bonds purchased at a discount (below par) will always be higher than the stated interest or coupon rate.
Above Par Yield
The price of a bond purchased at a premium to its original $1,000 face amount (above par) is similarly expressed in terms of a percentage of its par value. When a fixed income bond is purchased at a price above par, the yield will always be lower than the fixed interest or coupon rate.
You Might Also Like :: How to Increase 401k Savings