Fixed Income Trading
Advanced Fixed Income Trading Concepts
Fixed Income Trading Strategy & Education
Fixed Income Trading Fixed Income Trading Strategy & Education
Yield Basis
What Is Yield Basis?
The yield basis is a method of quoting the price of a fixed-income security as a yield percentage, rather than as a dollar value. This allows bonds with varying characteristics to be easily compared.
Understanding Yield Basis
Unlike stocks, which are quoted in dollars, most bonds are quoted with a yield basis. For example, assume a company is listed with a 6.75% coupon rate and is set to mature 10 years from the date of issuance. The $1,000 par bond is trading at a dollar value of 940.
The yield basis can be calculated using the current yield formula presented as:
Coupon / Purchase Price
Following our example above, the coupon to be paid annually is 6.75% x $1,000 = $67.50. Therefore, the yield basis is $67.50 / $940 = 0.0718, or 7.18%. The bond will be quoted to investors as having a yield basis of 7.18%. The yield quote tells a bond trader that the bond is currently trading at a discount because its yield basis is greater than its coupon rate (6.75%). If the yield basis is less than the coupon rate, this would indicate that the bond is trading at a premium since a higher coupon rate increases the value of the bond in the markets. A bond trader could then compare the bond to others within a certain industry.
The yield basis of a pure discount instrument can be calculated using the bank discount yield formula, which is:
r = (Discount / Par Value) x (360/t) where
r = annualized yield
discount = Par value minus Purchase price
t = time left to maturity
360 = bank convention for the number of days in a year
Unlike the current yield, the bank discount yield takes the discount value from par and expresses it as a fraction of the par value, not the current price, of the bond. This method of calculating the yield basis assumes simple interest, that is, no compounding effect is factored in. Treasury bills are quoted only on a bank discount basis.
For example, assume a Treasury bill with a $1,000 face value is selling for $970. If its time to maturity is 180 days, the yield basis will be:
r = [($1,000 - $970)/$1,000] x (360/180)
r = ($30/$1,000) x 2
r = 0.06, or 6%
As Treasury bills pay no coupon, the bondholder will earn a dollar return equal to the discount if the bond is held until it matures.
Pure Discount Instrument
A pure discount instrument is a type of security that pays no income until maturity; upon expiration, the holder receives the face value of the instrument.
Bank Discount Basis
Bank discount basis is a convention used when quoting prices for fixed income securities sold at a discount, such as U.S. Treasury bills.
Yield to Maturity (YTM)
Yield to maturity (YTM) is the total return expected on a bond if the bond is held until maturity.
Nominal Yield Definition
A bond's nominal yield, depicted as a percentage, is calculated by dividing all the annual interest payments by the face value of the bond.
Bond Valuation: What's the Fair Value of a Bond?
Bond valuation is a technique for determining the theoretical fair value of a particular bond.
Understanding the Coupon Equivalent Rate (CER)
The coupon equivalent rate (CER) is an alternative calculation of coupon rate used to compare zero-coupon and coupon fixed-income securities.
Fixed Income Essentials
How to Compare the Yields of Different Bonds
Current yield vs yield to maturity
Learn to Calculate Yield to Maturity in MS Excel
Continuous Compound Interest
Yield to Maturity – YTM vs. Spot Rate: What's the Difference?
Do You Know the 4 Types of Debt Yields?