What is a Redemption Yield?
The redemption yield is the proportionate return somebody buying a bond today will receive if he or she holds the bond until its maturity. The figure will include both the interest payments made on the bond, and any profit or loss that results from the difference between the bond's face value and the amount somebody pays for it. The redemption yield is also known as the yield to maturity.
A bond is a way a large company or public body can raise cash. It involves selling the bond to an investor and then returning the cash after a fixed term. There will usually be provision for making interest payments either during the term, upon maturity, or both. Bonds can be sold between investors before they mature, with the price usually varying depending on how long the bond has left to run.
The redemption yield will often be compared with the coupon rate. This is the rate at which interest is paid upon the bond in comparison to the face value. If the coupon rate is higher than the redemption yield, is it described as selling at a premium; if it is lower then it sells at a discount; and if the two are equal, it is sold at par.
Two elements make up the redemption yield: the yield on gains and the yield on income. The former is simply the profit, or in rare cases, the loss which will be made from the difference between the price paid for the bond and the face value which is returned on maturity. The latter is the total interest payments as a percentage of the price paid for the bond. This will not necessarily be the same as the coupon rate as, for example, a bond with a face value of $100 US Dollars (USD) nd a coupon rate of five percent will pay $5 USD interest. If, however, an investor buys the bond for $50 USD, they will still get $5 USD interest, but it will represent a yield on income of ten percent.
There are several variants on the redemption yield which apply to particular types of bond. For those where the issuer has the right to repay the money earlier, the "yield to call" figure takes account of the fact that less interest will be paid if this happens. The "yield to put" is used for a situation where the holder of the bond has the right to cash it in early. The "yield to worst" is used where a bond has one or more of these options and represents the lowest possible yield.
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