ROI, meaning return on investment is among the frequently used terms by investors to arrive at the return on various financial ventures and that includes bonds too. Readers who do not know how to calculate a bond return should know that it’s calculated by dividing the total sum paid to bondholder during the duration of bond by the price of bond and multiplying the result by 100. So, the final result you get is in percentage and used for making comparisons of ROI from diverse investments to determine your best options.
1. Know the coupon rate, which is generally mentioned on the face and title of the bond. That’s the percentage rate payable by the bond issuer.
2. Find out the sum paid for buying bond, which is often $1,000 but may vary. You can buy certain bonds at par, meaning its face value. You may also buy bonds by paying a premium, meaning you’ll need to pay excess of $1,000. Likewise, certain bonds are sold at discounted price also, meaning less than the face value of the bond. The price is mentioned on trade ticket that investor gets on buying a security. Else, you can get a copy from your financial advisor or broker.
3. Work out the annual payment by way of coupons. For example, if you posses a bond having a face value of $1000 and carrying a coupon rate of seven percent, you’ll get 7X1,000/100=$70
4. The next step of How to Calculate a Bond Return involves computing profit on selling the bond at its maturity. In case you bought the bond by paying a premium or at a discounted price, meaning above or below its face value, make sure to include the difference in the prices that you get paid on its maturity. For example, if you bought a bond for $950 and its redemption price is $1,000, you need to include $50 to the full return price of that bond.
5. Interest on bond is compounded rate of interest, meaning you earn interest over interest. Here’s an illustration. Suppose you had a bond of face value $1,000 with coupon rate of 7 % and a maturity period of five years. It means every year you are entitled for $70 for the duration of bond. So you would earn $350 as interest for five years. But in fact you’ll earn more than $350 because of compounded rate of interest. On using a calculator for compounding interest, you’ll realize that the interest earned by you is $430.64 over a period of five years! This is because interest gets compounded every year and additional amount is paid at the end of every compounding year.
6. Now, let’s find out the entire return form the bond. It’s equal to the total of coupon payments over five years plus the difference of face value of the band and the actual price you paid for the bond. In the ongoing example it come to $430.64+50=$480.64
7. This is the final step of How to Calculate a Bond Return. The total returns should be divided by the sum paid for buying the bond and multiply the result by 100 to get percentage bond return. So, in the present case it comes to $480.64X100/950=50.6%
Now that you are aware of How to Calculate a Bond Return, you are prepared for making judicious investments.