No. of Recommendations: 1
But if one were to buy the bond later on, after some of this movement, they buy it on the secondary market and pay current face value. Let's say par value was $100, and the price has gone up so one has to pay $110. If the initial coupon was at 5%, the new 'yield to maturity' for the person paying $110 would be 4.5%, correct? When the bond comes due, does that investor get back their initial investment (at the $110 price) or do they get paid back at par value, and thus also lose 10% of their initial capital investment?

Actually the *Current yield* will be about 4.55%. The *Yield to Maturity* will be much different, depending on how much time remains until maturity. That 10% premium you pay would be spread over the remaining time to maturity, which affects the calculation. Say you have 5 years remaining to maturity. That 10% premium reduces your YTM by about 2% per year, to about 3%. That's not exact, because it's usually figured on a compound basis, conventionally semiannually or quarterly, as the bond interest payments go. Actually, as you can see, a 10% premium is a pretty big deal.

I assume the latter (because why would a bond issuer be responsible for paying back the higher value), and if that's the case, the investor has to go into that investment knowing their yield is lower and also calculating in the capital loss at the end, correct? Or does the 'yield to maturity' figure include that capital loss in the calculation?

Here, your assumption is correct. The premium you pay produces the capital loss component, and is factored into the YTM calculation.

Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.