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How To Calculate How Much Money You Will Make On A Bond

Aug 17, 2007
If you're going to play the market, you're most likely in it to win. You expect a modest return on your investment, or at least to make your money back. Your choice of investment matters a lot, so it really helps if you can calculate how much money you can expect to make. The most general meaning of yield is the amount of money returned (usually annually) in the form of dividends.

1. Current Yield

If you are looking to estimate the amount of money you stand to gain, the procedure is really quite simple. Divide the annual interest amount paid by the current market price. CY = IAP*100. (The 100 turns the fraction into a percentage.) For example, a $1000 face-value (par) bond with a coupon (interest rate) of 7% that matures in 10 years may sell currently at a discount for $950.

2. Holding Your Bond To Maturity

You will gain the most money in dividends if you hold your bond to maturity. Would you rather have $1000 today or $1000 a year from now, even assuming you're assured of getting paid in a year? Having $1000 sooner rather than later means earning interest on that $1000 for an additional year!

3. Years To Maturity

YTM is the best number to use when comparing bonds with different rates and maturity dates. With a little practice, the process becomes familiar and loses the aura of numerology. Profits go to the fearless. Here's the formula...

c(1 + YTM)-1 + c(1 + YTM)-2 + . . . + c(1 + YTM)-YUM + B(1 + YTM)-YUM = P

c = annual coupon payment (in dollars, not a percentage)
YUM = number of years until maturity
B = par value (original issue price)
P = purchase price

If you do decide to go with a bond, first of all, expect to pay a minimum of $5,000. You will definitely want to invest in a bond that is rated AA or higher, and stick to a well known, major brokerage to handle your investment. Even with inflation you can expect to make only 4% profit per year. Of course, 4% of $5,000 is only $200, but over a period of 10 years that turns into $2,000. Of course, in today's economy $2,000 won't even last a month for rent, food, utilities, etc. Even so, bonds have many advantages. Since they have a set interest rate and maturity date, their behavior is much more readily predictable, given plausible assumptions about interest rate changes and other economic factors. You can't attribute this kind of reliability to stocks, for example.
About the Author
For more great bond related articles and resources check out http://topbonds.info
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