Bond Yield

A bond’s yield is the amount that it pays each year in interest as a percentage of its current price. For example, if a bond is sold at $100 and pays $5 per year, its yield is 5%. When the price of a bond goes up, its yield goes down – if that same bond is now being sold for $105, its yield would be 4.76% (5/105). And the same applies the other way around – if the price of that bond dropped to $95, its yield would go up to 5.26% (5/95). A bond’s yield (as per its current price) is, effectively, its current interest rate.

There’s an important difference between bond yields” and interest rates: confusingly, the term “interest rates” sometimes refers to both categories – where in reality, interest rates and yields can move in different directions. Yields are often thought of as the interest rates of bonds, but they’re actually not. Interest rates change with the market, which means that if you have a savings account and interest rates go up, you’ll get paid more in interest. The same is not true with bonds – if you have a bond and interest rates go up, the amount that you’ll get paid will not change. It might change as a percentageof the price of the bond (i.e. the yield might change) but the actual amount of dollars you’ll receive won’t change for the duration of the bond.