Bond yields

An investor buying a bond needs to know what return to expect. The flat yield (FY) focuses on income – it’s the annual coupon as a percentage of the bond’s price. So if a four-year bond costs £96 and pays an annual coupon of 6% (always a percentage of the bond’s face or par value of £100), the flat yield is (6/96) x 100%, or 6.25%.

But that ignores the fact that you pay only £96 for a bond that can be cashed in later for £100 – in other words, there’s a future capital gain to consider too. The gross redemption yield (GRY) builds this in. The exact calculation is complex. As a rough guide, you could say the investor will make a £1 capital gain, i.e. (£100-96)/4, every year. So the GRY is more like (6+1)/96, or about 7.3%.

• See Tim Bennett’s video tutorial: Bond basics.

Merryn

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