WHAT IS YIELD?

Yield is a measure of the amount of income (return) an investment generates over time.  It is usually expressed as a percentage of its price.  A bond's yield is its annual interest rate (coupon) divided by its current market price.  When a bond's price rises, its yield drops, and vice versa.  In general, the higher a bond's credit and interest rate risk, the higher its yield. Yield-to-maturity tells you the total return you will gain from a bond if you hold onto it until it matures (is paid back) or is called (is bought back).  It includes the par value (or face value), the total interest you have earned on the bond, and any gains or losses in its market price.

In general, the longer money is invested, the greater the total return.  In the case of bonds, this means the longer the maturity, the higher the yield.  Short-term bonds have lower yields to reflect the lower risk of market changes.

Bond prices change over time because of variations in interest rates.  When interest rates rise, bond prices fall to bring the yields of older bonds in line with newer, high-interest issues.  When interest rates fall, bond prices rise.  Bond yields of different maturities react differently to changes in interest rates.  Bonds with short maturities are less sensitive to interest rate changes than bonds with long maturities.

In the next section, we will look at how interest rates affect the yields of bonds with different maturities.