What is the yield on this bond? When an investor asks that question, the answer will depend on what he or she is really asking. If you are looking for high bond yields, you are most likely looking for the highest yield to maturity. If you are looking for the highest interest payments, then you are seeking a high nominal yield or coupon rate.

Nominal Yield

When a bond is issued or first comes to market, it is issued with a fixed interest rate on the bond. This is known as the nominal yield. The interest that is paid to the bond holder is this rate paid to par value (the amount of bonds the investor owns). If an investor buys 10 bonds worth $10,000 par at a nominal yield or rate of 6%, they will get 6% of $10,000 per year. If the bond was not bought at a premium or discount, the overall yield to maturity would be 6%. If the bond was bought at a different price, the YTM could be lower or high than 6%.

The nominal yield or coupon rate is fixed and never changes and is paid to par only. If that same bond discussed above was bought for $10,200 (a $200 premium), the investor will still only earn 6% of $10,000. It is important to understand that your overall rate of return could be less than the coupon rate if the bond was purchased at a premium. It could also be higher if the bond was purchased below par - at a discount.

Yield To Maturity

The most important earning indicator is the yield to maturity. It is the combination of everything that matters: The coupon rate on the bond, the price that is paid and the years the bond is held. If a bond is bought at a premium, then the yield to maturity will be lower. If the bond is bought at a discount, then the YTM will be higher. This is because the nominal yield is only paid to par and you only get par back at maturity, so if you paid $10,200 for a bond, you are only getting interest on $10,000 and only getting $10,000 back at maturity. The $200 in that example does not earn anything, yet you have paid that. That is why the yield to maturity is lower.

In most cases, you are better off with a 4% bond selling at a discount to yield 7% vs. an 8% bond selling at a premium to yield 6%. One benefit of the 8% would be higher current income, but the overall YTM (your true yield) is lower than the 4% bond.

Current Yield

The term "current yield" refers to the combination of the stated coupon rate and the current price on the bond. If a bond has a nominal yield of 7% and the current price is $104 or $1040, if one bond is owned, the current yield would be 6.73% (7 divided by 104). The CY is not that important when evaluating a bond. The most important factors are the interest payments and the overall yield to maturity or call.

Yield To Call

If a bond can be called early, then you should examine what that yield to call would be. A YTC is the same as YTM, except it occurs earlier and the price you get for your bond on the call date may not always be par. If the call price is higher than your initial buy price, then the yield to call will be higher. If the bond is called below you initial price, then you lose. Bonds are usually called when interest rates decline and the issuer is looking to call back it's existing high rate debt.

Investing in bonds is safe and great for current income. Just remember to keep all the high yield or low yield factors in mind.

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Nick Hunter is the President of American Investment Training and the owner of http://www.brokerjobs.com

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