What Is Bond Yield?

Bond yield is the return an investor earns from holding a bond, usually expressed as a percentage of the price paid for it. It comes from the bond's interest payments plus any change in price over time. Yield moves opposite to bond price, and it changes based on factors like a bond's maturity length and how risky its issuer is.

How Maturities Affect Bond Yields

Bonds are an important part of any investment portfolio and understanding the difference in returns between bonds of different maturities is an essential step for investors. Generally, bonds with longer maturities will earn a higher return than shorter-term bonds. There are several reasons why this is true, and we’ll explore them in more detail here by looking at examples from both corporate bonds and treasury bonds.

Corporate Bonds

When it comes to corporate bonds, the main reason why longer-term bonds have higher returns is because they offer greater stability in terms of interest payments. For example, if you purchase a 5-year bond from a company with a 7% yield, you can be sure that the company will make payments according to that rate for the entire duration of the bond.

This provides investors with peace of mind that their investment will remain steady over time. While shorter-term bonds may offer a greater initial yield, it’s likely that market conditions or other events could lead to lower yields over time as the market fluctuates.

Longer-term corporate bonds also tend to offer higher yields because the issuing company is taking on more risk when issuing them. The company has to commit to making interest payments for a longer period of time than if it were to issue shorter-term debt. As such, it’s necessary for it to offer investors higher yields in order to compensate them for taking on this additional risk.

Treasury Bonds

The same principle applies when looking at treasury bonds – those with longer maturities typically have higher yields than those with shorter maturities. This is because these types of investments are considered to be among the safest options available due to their guarantee by the U.S government (although there are still risks involved).

As such, investors feel more secure investing in these kinds of securities and so they usually require less compensation (in terms of yield) than other kinds of investments do.

As an example, 10-year treasury bonds currently have an average yield of around 1.55%, while 30-year treasury bonds have an average yield of 2%. As we can see here, even though both types of investments provide very low yields compared to many other types of investments out there, longer term treasuries still tend to offer slightly better rates than shorter ones due their added security and stability associated with them being backed by the U.S government.

The Bottom Line On Bond Yields

Overall, it’s clear that there is a definite advantage when investing in longer maturity bonds compared to short term ones - especially when looking at corporate or treasury securities where investors receive additional stability and security along with potentially higher returns on their investments.

By understanding these differences between long term and short term bond investing strategies investors are better able position themselves to maximize their returns whilst reducing potential risks associated with volatile markets or unexpected changes in interest rates over time

Questions

1. Analyze the relationship between market conditions and the yield fluctuations of shorter-term bonds versus the steadiness of longer-term bonds. How does this impact an investor's decision-making process of which type of bond to invest in?
2. What are the advantages and disadvantages of investing in corporate and treasury bonds?
3. What potential risks remain for investors in treasury bonds, despite their backing by the U.S. government, and how do these risks compare with those of corporate bonds?

Watching Yield Move in Real Time

The article above walks through why maturity length changes yield, but the other big driver of bond yield is something that changes every single day: interest rates set by the broader economy. When rates in the economy rise, newly issued bonds pay more, so older bonds paying a lower rate become less attractive at their original price. Their price drops until their yield lines up with what new bonds are offering. That's the inverse relationship between bond price and bond yield, and it applies to a 5-year corporate bond or a 30-year treasury bond exactly the same way.

This relationship is easier to feel than to memorize. Inside the Rapunzl investing simulator, which starts every student with a simulated $10,000 portfolio, students can hold a bond position and watch its yield and price move in opposite directions as conditions shift, the same mechanic described in the treasury bond example above. Checking live market data for current treasury yields alongside that trade shows students where today's rates actually sit compared to the 1.55% and 2% figures in the article, since those numbers move from one year to the next. That yield percentage also answers a second question, how long it takes an investment to double, which the Rule of 72 estimates by dividing 72 by the yield, a calculation practiced in Rapunzl's Rule of 72 worksheet.

Understanding yield this way, as a price that adjusts to risk and time, makes the rest of the bond market easier to read, from corporate debt to the mortgage bonds covered elsewhere in the curriculum. It also explains why two bonds from the same company, issued just a few years apart, can carry noticeably different yields even though nothing about the company itself has changed.

This explainer comes from Module 4 of the Rapunzl curriculum, part of the Power of Debt & Bonds unit. Teachers: the accompanying activity and answer key are in the teacher portal.