If you’ve ever explored the bond market, you’ve likely come across the term nominal yield. While it might sound technical at first, the concept is actually quite straightforward.
In this blog, we’ll break down what nominal yield means, how to calculate it step by step, when it’s useful, etc. Whether you’re new to bonds or simply refreshing your knowledge, this guide will help you understand nominal yield with ease.
Understand the Nominal Yield
The interest amount a bond pays you annually expressed as a percentage of its face value is known as the nominal yield, or coupon yield. It is calculated by dividing the annual coupon payment by the bond’s face value. Nominal yield does not take into account the bond’s market price, purchase price, or holding period.
Some Points to Remember:
- The nominal yield remains constant regardless of the bond’s market price.
- Buying the bond for more or less than its face value has nothing to do with your nominal yield.
- Additionally, you should consider factors like the yield to maturity (YTM) and current yield if you want a better idea of your actual earnings.
Nominal Yield Formula
Nominal Yield = (Annual Coupon Payment / Face Value of the bond) * 100
where,
- Annual coupon payment is the fixed interest amount the bond pays you every year.
- Face Value is the original value of the bond
Step-by-Step Calculation
Suppose you have a bond that is worth ₹1,000 and every year it pays you ₹80 as interest or coupon payments, which is called the annual coupon.
Step 1: Find out the annual coupon payment
This is the interest amount the bond pays you every year. In this case, it’s ₹80.
Step 2: Find out bond’s face value
The face value (also called par value) is the original value of the bond, i.e., the amount the issuer agrees to repay the bondholder at maturity. In most cases, bonds are issued with a face value of ₹1,000 (sometimes ₹100 for smaller bonds). In this example, it is ₹1,000.
Step 3: Apply the Formula
So here:
Nominal Yield = (80 /1000) × 100 = 8%
Step 4: What does that mean?
It means that your bond will pay you 8% of its face value of ₹1,000 each year. As long as you keep the bond, you will receive ₹80 every year.
Uses of Nominal Yield
1. Immediate Bond Comparisons
Are you having trouble choosing between several bonds? You can quickly figure out which one pays higher interest based on face value by looking at nominal yield.
For instance, you already know that Bond B pays you more annually, without using a calculator if Bond A has a nominal yield of 7% and Bond B has 9%.
2. A Simple Method to View Your Interest Income
Simply put, nominal yield indicates how much money you will receive annually from the bond. It is helpful when all you want to know is, “How much will I earn?
3. Effective, If the Bond Is Up to Par
Nominal yield actually provides you with a fairly accurate picture of your return if the bond is selling for the same price as its face value.
4. Ideal for New Investors
Nominal yield is a simple way for beginners to understand bond returns. It shows the fixed annual interest as a percentage of the bond’s face value, without involving complex calculations or market price fluctuations.
5. Useful for Financial Planning
Nominal yield makes financial planning easier if you are looking for a steady income by estimating how much you will receive annually.
Read Also: What are Bond Yields?
Difference between Nominal Yield & Current Yield
| Feature | Nominal Yield | Current Yield |
|---|---|---|
| Definition | The bond’s fixed yearly interest based on face value | The return you’re getting right now based on the market price of the bond |
| Formula | (Annual Coupon ÷ Face Value) × 100 | (Annual Coupon ÷ Market Price) × 100 |
| What’s it based on? | The original value of the bond (face value) | The actual market price of the bond |
| Does it change? | No, it stays the same | Yes, it moves as the bond’s market price changes |
| Good for beginners? | Absolutely. very simple to understand | Yes, but you need to know the bond’s market price |
| Consider Market Price? | No | Yes |
Limitations of Nominal Yield
1. It overlooks the true cost you incurred
Nominal yield doesn’t consider the bond’s purchase price; it only considers its initial (face) value. Therefore, the return on investment isn’t as high or low as it might appear if you purchase a bond for more or less than its face value.
2. Ignores the Bond’s Remaining Time
The nominal yield remains constant whether a bond matures in two years or twenty.
3. Ignores the Wider Picture
Nominal yield solely considers the annual interest you receive. It doesn’t account for things like;
- Variations in the market value of the bond
- If you decide to reinvest the interest
- Any increase or decrease in capital
- Or even inflation
4. It is Not Very Helpful If the Bond Isn’t Real
Particularly in the secondary market, most bonds are not traded at their exact face value. The nominal yield may provide a completely inaccurate picture of the true return if a bond is being sold at a premium or discount.
5. It is Not the Best Option for Long-Term Planning
It is not the most reliable figure if you plan on investing long-term because it leaves out a lot of information, such as future interest rate changes or how long you will hold the bond.
Read Also: What is Coupon Bond?
Conclusion
If you want to quickly gauge how much interest a bond pays annually, nominal yield is good. It is simple, easy to understand, and ideal for situations in which a bond is trading at face value.
But remember, it just gives you an overview. The expected total return, the number of years you will hold the bond, and the actual price you paid are not considered. For a more complete picture, you should also consider other metrics like yield to maturity (YTM) and current yield.
The bottom line? Nominal yield is a useful starting point, but it should not be the only factor in your decision-making. Think of it as the starting point for smarter, more informed bond investing.
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Frequently Asked Questions(FAQs)
Is the nominal yield just another word for the interest rate?
Yes! The coupon rate is also known as the rate the bond promises to pay each year.
Is it possible for nominal yield to change over time?
No! Even if the market price goes up or down, it stays the same for the life of the bond.
What sets apart current yield from nominal yield?
Current yield is based on the bond’s current market price, which is generally more accurate than nominal yield, and is based on the bond’s face value.
Is nominal yield useful if I did not pay full price for the bond?
Not really. If you bought the bond for less or more than its face value, the nominal yield does not reflect how much money you actually made.
Do zero-coupon bonds have a yield?
No! They do not have a nominal yield because they don’t pay interest every year.
