Understanding yields

When it comes to running yield comparisons we would always recommend caution. The measure itself is not widely used by institutional fixed income practioners as can be misleading as it does not show the full picture. The measure only reflects the income side and not the capital gain/loss at the call date or maturity which will depend on the price paid for the bond. The industry standard for comparing bond yields including hybrid type securities like subordinated debt and ASX listed hybrids is yield to call or yield to worst. Running yield does not fully take into account the current price of the bond. Let’s look at an example.

Bond 1
Original notional (issue price) = 100
Current Price – $100
Coupon – $2.50 per year or 2.5%p.a. of the original notional
Term remaining to call date – 5 years
Payable at call date – 100

Running yield = 2.5/100 = 2.5% p.a
Yield to call = 2.5% p.a

Bond 2
Original notional (issue price) = 100
Current Price – $105
Coupon – $3.00 per year or 3.0%p.a. of the original notional
Term remaining to call date – 5 years
Payable at call date – 100

Running yield = 3/105 = 2.86% p.a
Yield to call = 2.0% p.a

The running yield on Bond 2 is higher than on Bond 1 as the running yield formula does not fully account for the fact that the bond is trading above par or the amount payable at the call date.