How to Calculate Redemption and Running Yields on a Bond
If you are sitting a CII investment exam, then we can almost guarantee that you will have to work out the yield on a bond and probably both the running yield as well as the redemption yield. So here’s a quick reminder of how to do it.
Also known as the flat yield or income yield, running yield is simply measuring the annual income being received as a percentage of the price paid – in other words what you are getting back as a percentage of what you gave. The formula is:
So if a bond is priced at a clean price of £120 and it’s paying a coupon of 5% then you divide 5% by £120 to get 0.04166 – multiply this by 100 to get 4.17%.
The investor actually receives £5 gross each year, but because the price paid was more than £100 (it was trading above par), then the equivalent return is less than 5%.
To take this one step further, we need to remember that if this bond is held until redemption, the investor will only get back £100 so will make a loss.Here's how to calculate Running and Redemption Yields on a bond. Click To Tweet
So let’s now calculate the redemption yield assuming the investor does hold it until maturity.
Let’s assume the bond has 6 years left to run.
It was bought for £120, so at maturity there will be a capital loss of £20. With 6 years left to run, we can say that this is a £3.33 capital loss for each year left. As a percentage of the price that was paid this is – 2.78%. We then take this from the running yield we worked out earlier of 4.17% to give an approximate yield to redemption of 1.39%.
The formula is:
Anyone taking a CII investment exam would be wise to practise these two calculations.
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