Among the corporate and government bonds bought and sold in the stock market, sometimes the purchase price, the annual interest rate, and the maturity value are all the same amount.
Suppose this amount is $1,000, and the annual interest is $40. This interest is at the rate of four percent per annum on the par value, and in this case four percent is also the yield, meaning the annual interest amount divided by the price.
But usually the purchase price on a bond is not the same as par or maturity value, and this difference gives two ways to figure yield. Suppose the current price of the bond is $800, whereas it will mature at $1,000. Ignoring the maturity value, we say the "current yield" is the annual interest, $40, divided by the price, which gives five percent. But at maturity, this bond will have a value $200 more than its current price.
The "yield to maturity" includes the prospective change in value as well as the annual interest. We skip the details of this calculation, because our purpose here is merely to show that for a bond the yield is a useful idea, with two different but definite meanings.
When a bond has a high yield, compared to other bonds, it means that for some reason the consensus of opinion in the market is more critical of this bond. Maybe there is doubt that interest and principal will be paid on time. Or maybe the issue is small, or the issuer is not well known, making it harder for a bond-owner to sell, if he should want to, before maturity. At present, the yield tends to be higher on a bond with a more distant maturity. And of course, if a bond is exempt from some taxes, especially federal income tax, that causes it to sell at a higher price, thus lowering the yield.
On E bonds and other savings bonds issued by the U. S. government, with rigid schedules of values and interest payments, the yield has a peculiar meaning. On an E bond, semi-annual increases in redemption value take the place of interest payments. In the schedule announced in 1957, after a bond costing $75 has been held six months, its value rises $0.60. To adjust this to a 12-month basis, we double the amount of increase, making it $1.20. This divided by the cost gives 1.6 percent, which we can call either the annual interest rate, or the yield, on the purchase price, for the first six-month period.
When an owner continues to hold an E bond, at each semi-annual date the increase in value is greater than the first one, and the yield on cost rises accordingly. On a bond held to maturity, eight years and 11 months after purchase, the total appreciation on $75 cost is $25, equivalent to an annual interest rate or a yield to maturity of 3.25 percent on the purchase price. For accuracy, we should add that interest or yield on E bonds is figured as being compounded semi-annually.
Cautious investors can count on government bonds to produce a steady and predictable, if low, yield. Adding bonds to your portfolio can be a good way to diversify and ensure a continued income flow.