Essays on Bond Yield Measures Inform Investors Of The Rate Of Return On Bonds Under Different Assumptions Assignment

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DIFFERENT WAYS OF MEASURING BOND YIELDIt is important for any investor to understand the instruments used in money market (Tavella and Randall, 2000). One of such instruments is the bond yielding, this paper tries to explain bond yielding and the different measures of yielding in the security markets. Chambers and Carleton (2001) define bond yielding as that return an investor earns on a bond when it reaches maturity stage in the market. Another scholar, (Bierwang, 2007 p. 76) defines bond yielding as, "the percentage on the return on investment on bonds which must be within a given specified period of time".

From the above definitions, the yield can also be referred to as that interest rate that equalises the current value of investment of cash flows to the investment cost, known as the internal rate of return for any investment. This can be written mathematically as follows; PI = Where; PI= price of that investmentCFN = cash flow for the year NN= number of yearsThere are several bond market yields in the bond market which can be quoted by the investors and the measures of the yield used by portfolio managers.

These are cash flow yield, yield to maturity, yield to call, yield spread measures, yield for portfolio, yield to worst, yield to put and current yield. These can further be discussed as follows; Yield to put/Current yieldIn this situation, the bond issue is putable, that is, the person issuing the bond can be forced by the bond holder to quote the specific bond price (Bank for International Settlements, 2007). We can therefore define yield to put as that rate of interest that can make the current value of inflow cash be overlooked until the put date where after it will be added to the put price of that said date (Tavella and Randall, 2000).

Mathematically this can be stated as follows; YP = Where M* is the put price and n* is the timeExampleConsider the following bonds given that maturity date is 20 years; coupon rate is 15%, per value is $ 1000 and the first call is in the 5th year. Calculate the first callSolutionYP = = 1000(1/ (1+0.15)5)= $497.18Yield to callThis can be defined as the return that an investor gets for waiting with the bond until date of call (Audrino, and De Giorgi, 2007).

It is therefore assumed that the investor is in a position to call the bond at a particular date making it necessary to calculate the call price – the price at which the bond is called. Yield to call is calculated the same way as yield to put only that the M* in this case represents the call price. Current yieldIn this case the investor finds the annual percentage rate on the bonds invested.

It often relates to the annual market price and the interest rates of the coupons. Current yield can be calculated as follows; CY = IRc / PBWhereCY is the current yieldIRc is annual interest rate of couponPB is price of bondsAccording to Ingersoll et al. (2003), interest rate of the coupon is the main factor to be considered in the calculation of current yield.

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