How To Calculate The Rate Of Return For A Convertible Bond ?
| If you want to learn how to calculate the rate of return for a convertible bond, you first have to understand the different indicators that are involved. Rate of return or yield is based on the price paid, coupon rate and the maturity length. |
The three main indicators are as follows:
Nominal Rate:
This refers to the fixed rate of interest. This is the rate that an issuer pays to par value. It is fixed and it never changes, and as mentioned before, this rate is just paid to par. Par refers to the amount of bonds a bond holder owns and an yield may or may not be the total net rate of return. If a bond holder purchases a bond at above par, the overall yield to maturity will always be lower than the coupon rate. However, a bond that is bought at a discount will have the opposite effect on the yield. The yield to maturity in this case will be higher. This is because the bond holder will earn interest on par even if he paid under par for the bond.
Current Yield:
A bond holder can calculate this by dividing the nominal rate by the current market price. Here too, a bond purchased at above par will have lower yield in comparison to the coupon rate of the bond. A bond purchased at lower price than the value will have a higher yield.
Yield To Maturity:
This is the most important indicator in the rate of return of a convertible bond. Also known as YTM, and gives the true overall yield after taking into account everything. It takes into account nominal rate, current yield and years for the bond to mature. There is no doubt that the overall rate of return for a convertible bond can be affected the length of time the bond is held.
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