When investing in bonds, you will often hear the term ‘yield.’ But what does yield mean?

To put it simply, the yield is the total you earn from a bond over a set period of time.

A bond’s yield is influenced by the current market climate, meaning how much investors can demand for lending money to an issuer for a specified period of time. The yield of a bond is also based on the price paid for the bond, its coupon and the bond’s term-to-maturity.

When it comes to the price of a bond, this can be impacted by a number of factors, including:

• the creditworthiness of the issuer
• the overall economic outlook and inflation rate and
• changes to interest rates set by central banks.

A bond’s yield and price have an inverse relationship, meaning they move in opposite directions.

So, when yields rise, bond prices fall. And when yields fall, bond prices rise.

Let’s look at an example: Say you buy a bond for one thousand dollars that has a coupon of six percent, which earns you sixty dollars in interest each year. Since you bought the bond at par, the yield is the same as the rate of its coupon.

Now let’s say market yields increase by one percent. This means new bonds will now offer an interest payment of seven percent – or $70 – on one thousand dollars.

Because investors are now able to buy a bond with a higher interest payment, not as many people will want to buy a bond that pays six per cent. The price of your six percent bond will fall, causing its yield to rise to seven percent to remain in line with the market.

Another term often used in discussions about bonds is duration.

Duration is a measurement of how sensitive a bond is to changes in interest rates, and is expressed as a number of years.

For example, generally, if a bond has a four-year duration its price would either rise or fall by four percent for every one percent change in yield.  

Typically, the further away a bond is from its maturity date, the longer its duration, and the more its price could change when yields move. If you want to invest in a bond fund, a good rule of thumb is to choose an overall duration that is equal to your investment time horizon.

But remember, even if bond prices fall, there’s still a silver lining: you can reinvest your coupon or interest payments at this new higher yield. Over time, that higher reinvestment rate will help offset the fall in the bond’s price.

To learn more about fixed income investing, talk to your financial advisor or visit rbcgam.com.