Gilts and bonds

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7. Calculation of current yield

If you are buying bonds sometime after issue, the nominal yield will not be the best measure of their income productivity if the price you pay is higher or lower than the nominal price.

To see why this is so, take two investors, both of whom buy a £100 bond paying 8% annual interest, but one year apart.

• Investor A buys the bond at issue, paying the nominal price of £100
• Investor B buys the bond a year later, paying a discounted market price of £95

They both receive £8 per year in interest, but whereas A invested £100 B invested only £95. Clearly, B has got the better deal. His investment was bought at a higher yield. But how much higher?

To calculate yield, divide the expected annual income by the current market price and multiply by 100.

• In A's case, 8/100 x 100 = yield of 8%
• In B's case, 8/95 x 100 = yield of 8.42%

Those were the yields at the time A and B bought the bonds. But the current yield changes as the market price of the bond changes. Basically, the higher the market price, the lower the yield. To see how yields go up and down when the variables change, try experimenting with this yield calculator.

Current yield on income calculator Annual income   % Current price of bond       Yield:    %

The limitation of 'current yield' is that it only provides a snapshot based on current market price and takes no account of the capital gain or loss that an investor will make if he holds the bond to maturity.

We'll look a third type of yield calculation on page 9. But first - how exactly do you make a capital gain on a bond?

1. What are bonds? 2. Different types of issuer 3. Different types of bond 4. Bonds compared to shares 5. Bonds as tradeable instruments 6. Nominal yield 7. Calculation of current yield 8. Capital gains on gilts and bonds 9. Calculating the redemption yield 10. Factors which affect bond prices 11. Are bonds for you? 12. Selecting gilts and bonds 13. How to buy gilts and bonds 14. Unit trusts and bond funds 15. Keeping track of your bond investments 16. Tax 17. Conclusion

• First Steps in Bonds
• Beating the Dow with Bonds
• Pricing Convertible Bonds