The Basic Yield Basis Explained
The yield basis is a method employed to quote the price of a fixed-income security as a yield percentage rather than as a dollar value. This approach provides an easier way to compare bonds with different characteristics. The formula used to calculate the yield basis is the annual coupon amount divided by the bond’s purchase price.
Key Insights
- The yield basis method quotes the price of a fixed-income security as a yield percentage, enhancing comparability across bonds.
- It enables swift and straightforward comparisons of various bonds by potential buyers.
- Yield quotes help bond traders determine if a bond is trading at a discount or a premium.
- When purchasing on a net yield basis, the yield includes the broker’s profit or markup.
Grasping Yield Basis: An Example
Unlike stocks quoted in dollars, bonds are often quoted on a yield basis. For instance, consider a company with a 6.75% coupon rate, maturing 10 years from issuance, and a $1,000 par bond trading at $940. The yield basis is calculated using the current yield formula:
Coupon Amount / Purchase Price
In this example:
- Annual coupon: 6.75% of $1,000 = $67.50
- Yield basis: $67.50 / $940 = 0.0718 or 7.18%
tlquote Treasury BillsWith a yield basis of 7.18%, it is evident the bond trades at a discount due to the higher yield basis compared to the 6.75% coupon rate.
Mastering Bank Discount Yield
For pure discount instruments, the bank discount yield formula calculates the yield basis:
r = frac(Value_from_Par (360 / t) ) where
r = Annualized yield
Value_from_Par=(Discount_between_<=Par_Value<= purchase_price)`
t designated remaining time-period t
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t=0 t Principal_1 Discount provided full yield rate_attributes expansive t_code.
Related Terms: coupon rate, current yield, at a discount, at a premium, net yield basis.
References
Get ready to put your knowledge to the test with this intriguing quiz!
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## What is "yield basis" primarily used to compare?
- [x] The return on investment between different bonds
- [ ] The liquidity of different assets
- [ ] The volatility of stock prices
- [ ] The market capitalization of companies
## Which type of yields can be computed on a yield basis?
- [x] Current yield and yield to maturity
- [ ] Dividend yield only
- [ ] Capital gains yield only
- [ ] Taxable yield only
## What is the yield basis often reflective of in fixed-income securities?
- [x] An investor's expected rate of return
- [ ] An investor's risk tolerance
- [ ] An investor's equity holdings
- [ ] A company's profitability
## When comparing bonds using the yield basis, which bond typically appears more attractive?
- [ ] A bond with a lower yield
- [x] A bond with a higher yield
- [ ] A bond with a lower coupon rate
- [ ] A bond with a longer maturity
## How does yield basis assist in the decision-making process for bond investors?
- [ ] It illustrates historical share prices
- [ ] It minimizes trading costs
- [x] It allows for the comparison of returns
- [ ] It enhances liquidity risk
## What type of bonds can yield basis be used for?
- [x] Corporate bonds, municipal bonds, and government bonds
- [ ] Only corporate bonds
- [ ] Only municipal bonds
- [ ] Only short-term treasuries
## In the context of yield basis, what does a similar yield between two bonds indicate?
- [x] They have comparable levels of return
- [ ] They have the same maturity date
- [ ] They are issued by the same corporation
- [ ] They are priced identically
## Which of the following is true about yield basis?
- [ ] It only accounts for the face value of the bond
- [ ] It exclusively measures bond yield in percentage terms
- [x] It can consider compounding periods such as semiannual or annual
- [ ] It is irrelevant for Treasury bills
## Yield basis is particularly useful when comparing bonds that have:
- [ ] The same coupon rate
- [ ] Different trading volumes
- [x] Different interest payment structures
- [ ] Identical issuing periods
## What is another common use of the yield basis concept outside of bonds?
- [ ] Pricing stock options
- [ ] Calculating real estate property taxes
- [x] Evaluating discounted cash flow (DCF) models
- [ ] Assessing the market trend lines
