YOUNG INVESTORS FORUM

Emmanuel

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Yields

These are returns that bondholders are likely to receive as a result of investing in bonds. Yields (often expressed in %) compare the profits an investor has earned from the capital the investor has put down on a bond investment

Common types of yield measurements are
1. The flat or running yield

This metric measures the coupon payments an investor is entitled to receive in comparison to the price at which he/she bought the bond for.
Running Yield = (Coupon Payment/Market Price) *100%

Example: Let’s say Investor G purchased a 15 year Treasury bond with an annual coupon rate of 11.15% at a price of TZS 110. Her running yield would be calculated as follows:

Since the coupon rate is a return based off the bond’s par value of TZS 100 this means that the bond pays out TZS 11.15 of interest for every TZS 100 invested. However since Investor G bought the bond at a premium price of TZS 110 her running yield equals (TZS 11.15/ TZS 110)*100% = 10.14%.

Alternatively if Investor G bought the same bond at a price of say TZS 98 her running yield would result to (TZS 11.15/TZS 98)*100% = 11.37%

TIP: Since the coupon rate on an issued bond is constant the only way an investor can maximize his/her running yield is by purchasing the bond at the lowest price possible.

Relationship between bond prices, running yields & coupon rates
If a bond is bought at a discount then the running yield > coupon rate
If you bond is bought at a premium then the running yield < coupon rate
If you bond is bought at par value then the running yield = coupon rate



2.The Yield to Maturity (YTM) or Redemption Yield
This metric measures the total returns (coupon payments + capital gains/losses) an investor is expected to receive assuming that he or she buys the bond at a certain price and holds the bond until it matures.

Another key assumption behind the calculation is that coupon payments are reinvested at a constant interest rate until the bond’s maturity

It’s an extension of the running yield as it incorporates the elements of capital gains or losses if you bought the bond at a discount or premium.
YTM = (Coupon Payments + ((Par value - Market Price)/Number of Compounding periods))/((Par value + Market Price)/2) * 100%

Example: Let’s say Investor G purchased a 10-year Treasury bond offering an annual coupon of 10.25% at a price of TZS 96.8379.
YTM = (TZS 10.25 + ((TZS 100 - TZS 96.8379)/10))/((TZS 100 + TZS 96.8379)/2) * 100%
Her YTM would be 10.7360%

Relationship between bond prices, running yields, coupon rates & yield to maturity
If a bond is bought at a discount then the yield to maturity > running yield > coupon rate
If you bond is bought at a premium then the yield to maturity < running yield < coupon rate
If you bond is bought at par value then the yield to maturity = running yield = coupon rate

* The formula we indicated above provides a quick result of what the YTM for a bond would look like, the result might vary slightly from the actual YTM. There other more accurate & more complex calculations behind figuring out a more precise YTM for a bond but we decided to stick to this formula for simplicity sake.


Understand your borrower
If you’re intending to invest in corporate bonds read their information memorandum. It helps you understand the way the businesses operate, their financial situation, their management, their competition, the sector in which the business performs, their risk profile and so much more.

Reading these memorandums allows you to understand the institution you’re lending money to and whether the institution is creditworthy or not.

Remember: If you don’t understand the institution & the way it performs then its best not to invest in it.


Conclusive Remarks
For an investor to maximize his/her returns from investing in bonds he/she has to invest in bonds with higher coupons selling at the lowest possible prices (preferably discount price) & hold them to maturity

In case the investor wants to sell his/her bond before maturity he/she should also consider selling the bond at dirty price which includes the accrued interest he/she is entitled to

While seeking to maximize returns the investor should also take time to understand the institution he/she is lending money to and assess its financial strength, market, risks, sectorial & macroeconomic trends in order to identify whether the institution is creditworthy or not.

Written by: Emmanuel Andrew Matunda
Email: derickmatunda@gmail.com
Contacts: +255 689 973 988







Written by: Emmanuel Andrew Matunda



Email: derickmatunda@gmail.com
 
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YOUNG INVESTORS FORUM