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. The yield basis is calculated by dividing the coupon amount paid annually by the bond purchase price.
Key Takeaways
- The yield basis method quotes the price of a fixed-income security (such as a bond) as a yield percentage instead of a dollar value.
- The yield basis method helps bond buyers easily compare the characteristics of various bonds before making a purchase.
- The yield quote tells the bond trader whether the bond is currently trading at a discount or premium compared to other bonds.
- Purchasing a bond on a net yield basis means the yield also includes the broker's profit or markup for executing the trade.
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.
Bank Discount Yield
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.
Special Considerations
When purchasing bonds, it's important for the investor to understand the difference between the yield basis and the net yield basis. On the secondary market, you can purchase bonds through a broker/dealer, who could charge you a flat commission for this service. However, in lieu of a commission, your broker may opt to sell bonds on a net yield basis.
Net yield means the yield also includes the broker's profit for the transaction. This is the broker's markup, which is the difference between what the broker paid for the bonds and what the broker sells them for. If a broker offers bonds on a net yield basis, they've already included their markup. For example, if an online broker sells you a bond with a 3.75% yield to maturity (YTM), their profit is embedded directly in the price you pay and there is no separate commission.
When comparing various bonds for a possible purchase, bond buyers should ask their broker if the bonds are on a net yield basis or if they charge a separate commission to execute the trade. Brokers might charge other fees, such as a broker-assisted fee for transactions not conducted online. Your overall cost for the trade may also include accrued interest, which is the interest accrued on the bond between the last payment and the settlement date.
FAQs
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. The yield basis is calculated by dividing the coupon amount paid annually by the bond purchase price.
What does yield based mean? ›
A yield-based option is a contract that gives the buyer the right, but not the obligation, to purchase or sell at the underlying value, which is equal to 10 times the yield. Yields are expressed as percentage rates, and the underlying values for these options contracts are 10 times their yields.
What does it mean to be quoted on a yield basis? ›
Yield basis refers to a financial concept used to determine the yield or return on an investment or financial instrument, particularly fixed-income securities. It is a measure of the return an investor can expect to receive from an investment in relation to its cost or current market price.
How to calculate yield basis? ›
You can calculate a bond's yield by dividing its coupon payment by the bond's face value. Yields on mutual funds: Mutual fund yields include income from dividends and interest received over a period. You can calculate yields on the mutual fund by dividing the annual dividend by its share price.
What is the basis point of a yield? ›
Basis Point Value (BPV), also known as DV01 (the dollar value of a one basis point move) represents the change in the value of an asset due to a 0.01% change in the yield. BPV or DV01 calculations are used in many ways, but primarily to show the dollar amount of change for each increase or decrease in interest rates.
What is the yield basis method also called? ›
Note: Yield-Basis Method may also be termed as: Market Value Method; Profit Basis/Income Basis Method; Earning Capacity Method etc.
How do you explain yield? ›
What is yield? Yield refers to how much income an investment generates, separate from the principal. It's commonly used to refer to interest payments an investor receives on a bond or dividend payments on a stock. Yield is often expressed as a percentage, based on either the investment's market value or purchase price.
How do you calculate yield based? ›
Net yield is determined by first subtracting the property's annual operational costs from its annual rent and then dividing this by the property value.
What does yield result mean? ›
Yield means to produce (something). Result in and yield – two words that look completely synonymous in the dictionary. Both the words are used to describe the outcome of a particular phenomenon.
What is yield on cost basis? ›
Yield on cost (YOC) is a measure of dividend yield calculated by dividing a stock's current dividend by the price initially paid for that stock. For example, if an investor purchased a stock five years ago for $20, and its current dividend is $1.50 per share, then the YOC for that stock would be 7.5%.
What is the meaning of YTM? YTM is yield to maturity which means the total return you expect from your investment in bonds/debt mutual funds if the same is held till maturity. It is expressed as a percentage of the current market price. It is used for comparing different bonds and debt funds with different maturities.
What is yield defined as the amount of? ›
Yield measures the realized return on a security over a set period of time. Typically, it applies to various bonds and stocks and is presented as a percentage of a security's value. Key components that influence a security's yield include dividends or the price movements of a security.
What is the all in yield basis? ›
All-In Yield means the yield of the applicable Indebtedness, whether in the form of interest rate, margin, commitment or ticking fees, original issue discount, upfront fees, index floors or otherwise, in each case payable generally to lenders, provided that original issue discount and upfront fees shall be equated to ...
What is the yield basis spread? ›
A yield spread is the net difference between two interest bearing instruments, expressed in terms of percent or basis points (bps). An asset-backed security (ABS) is a debt security collateralized by a pool of assets.
What is the constant yield basis? ›
The constant yield method is a method of accretion of bond discounts, which translates to a gradual increase over time, given that the value of a discount bond increases over time until it equals the face value. The first step in the constant yield method is determining the yield to maturity (YTM).
What does an 80% yield mean? ›
At the other extreme, a yield of 0% means that no product was obtained. A percent yield of 80%–90% is usually considered good to excellent; a yield of 50% is only fair.
What does a 75% yield mean? ›
This is the theoretical yield of the reaction, i.e. what you would get at 100% yield. In your case, the reaction is known to have a percent yield equal to 75% . This essentially means that for every 100 moles of carbon dioxide that the reaction could theoretically produce, you only get 75 moles.
