What is Bond Yield? A Simple Explanation for Kids, Teens and Beginners

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Introduction to Bond Yield for Kids and Teens

This video explains the concept of yield of a bond in a simple, concise way for kids and beginners. It could be used by kids & teens to learn about yield, or used as a money & personal finance resource by parents and teachers as part of a Financial Literacy course or K-12 curriculum.

Suitable for students from grade levels:

• Kindergarten
• Elementary School
• Middle School
• High School

The topics covered are:

• What is Yield
• Other types of yields
• What causes a bond’s yield to fluctuate
• A detailed example

Old version:

• What is yield
• How is yield calculated
• Is your return from bond investment the same as the current yield
• Do all bonds have yield
• Do stocks have a yield

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What is Yield?

In simple terms, yield is the rate of return a bond generates. There are two main types of yield. 

Current Yield is the annual coupon payment expressed as a percentage of the current market price of the bond. It fluctuates as the price of the bond changes. 

Yield to maturity (YTM) is the average return of the bond over its remaining lifetime.

It takes into consideration the total expected returns on a bond if it’s held until its maturity date.

This includes all coupon payments, as well as the difference between the bond’s purchase price and its face value at maturity. 

Are there any other types of yield?

While current yield and yield to maturity are the two most important types of yield, there are a few other types.

Yield to Call, applicable to callable bonds, is similar to yield to maturity – but assumes the bond will be called at the earliest possible call date.

Yield to Worst is a worst-case-scenario estimate of the lowest potential returns from a bond. 

What causes a bond’s yield to fluctuate?

Yield is inversely related to the price of the bond – meaning when the bond price increases, its yield goes down and vice versa.

There are many factors that can cause a bond’s price and consequently its yield to fluctuate. 

The most important is prevailing interest rates. For example, when interest rates go up, new bonds are issued with a higher interest rate.

This makes existing bonds with lower interest rates less attractive. So their price decreases to compensate for this reduced demand. This lower price leads to an increased yield. 

Similarly, when the market interest rates fall, new bonds are issued at the lower rate making the existing bonds attractive due to their higher coupon rate.

This increases the demand for them, driving up their prices and leading to a lower yield.

Other factors include changes in the issuer’s credit rating, time until maturity, inflation, etc.

For example, if the bond issuer becomes less creditworthy, there will be less demand for that bond. This drives down its price, leading to a higher yield.

Can you give me an example?

Let’s say you own a bond with a face value of $1,000 and a coupon rate of 5%. This gives you $50 every year.

If the interest rate rises to 6%, new bonds will be issued at a 6% coupon rate, and no one will buy the 5% bonds.

The market price will adjust such that the $50 coupon provides an effective yield of 6%, making the bond price $833.

On the other hand, if the interest rate falls to 4%, new bonds will be issued at a 4% coupon rate, leading to an increased demand for the 5% bonds.

This will drive up its price until $50 provides an effective yield of 4%, making the bond’s price $1,250.

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Old version: What is Yield?

Howdy Wall St. Willy!

Sometime ago we talked about coupon and when we talked about that you said something about yield. But…

What is yield?

Yield is the rate of return you can get from making an investment in a bond at the current price.

It’s expressed as a percentage, just like interest rates.

How is yield calculated?

Bonds are bought and sold in the market and their price keeps changing. The yield is the coupon amount divided by the prevailing market price of the bond.

Yield = Coupon Amount / Market Price of Bond

For example, if the coupon payment on a bond is $5 and the current market price of the bond is $100, the yield is 5/100, which is 5%.

Yield = $5 / $100 = 5%

Is your return from bond investment the same as the current yield?

Your return depends on the price at which you bought the bond.

Let’s say the coupon payment on a bond is $5, you bought the bond at $50 and the current market price is $100. In this case your return is 5/50, which is 10%, although the current yield is only 5%.

The bottom line is that once you buy a bond, your rate of return is fixed and is determined ONLY by the price at which you bought it and it does not get impacted by any changes in the current yield.

Do all bonds have yield?

Yes, all bonds do have a yield. Even zero-coupon bonds have yield, which is calculated in a different way.

But we’ll talk about it when we discuss zero-coupon bonds.

Do stocks also have a yield?

Not really. There is something called a dividend yield for stocks but that’s a topic for another time.

Thank you very much for telling me about yield, Wall St. Willy.

You are welcome, Sooper Cooper.

Remember, Finance is Your Friend!

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Podcast: What is Yield for Bond?