A bond’s yield is simply what it generates for an investor in terms of income. There are two popular measures of bond yields. These are the current yield and the yield to maturity (YTM).
The current yield is calculated by taking the interest the bond currently pays annually (also known as the coupon) and dividing it by its current price. This tells you how much the bond will be worth to you if you buy now and hold it for a year.
However, bond prices are constantly fluctuating as economic conditions change. As a result, holding a bond for a year may not actually earn you what you thought it would when you calculated its yield in the above manner. This is why a second calculation is needed.
Yield to maturity is another calculation bond investors need to become familiar with. It tells you how much a bond will earn you if you hold it to maturity and reinvest all of your interest (coupon) payments back into it.
It’s a complex calculation, usually performed with software assistance and takes into account the bond’s market price, par value (face value), coupon interest rate and time to maturity.