Bonds are loans that are floated by companies and governments and bought by investors. Each bond has a par value, the amount the company will pay interest on, and a stated interest rate. However, bonds can be traded like stocks so you may have to pay more or less than the par value to purchase a bond. The more you have to pay, the lower your annual rate of return on the bond will be. In order to accurately determine whether a particular bond at a particular price is a good investment, you need to be able to calculate the annual rate of return.
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Determine the par price of the bond. This is the amount that the interest is calculated from, regardless of how much you pay to acquire the bond. For example, a company may issue a bond with a par value of £650 but you may have to pay more or less depending on the market circumstances.
Determine the stated interest rate on the bond. For example, a company may offer 6 per cent interest.
Determine how much you have to pay for the bond. When the market is performing well, you may be able to purchase the bond below par. However, if the market is performing poorly, you may have to pay more than the par value to acquire the bond.
Multiply the stated interest rate by the par value of the bond. For example, if the stated interest rate was 6 per cent and the par value was £650, you would get £39.
Divide the result from step 4 by the price you paid for the bond. For example, if you paid £617 for the aforementioned bond, you would divide £39 by £617 to get about 0.0632.
Multiply the result from step 5 by 100 to calculate the annual rate of return. For example, you would multiply 0.0632 by 100 to find the annual rate of return to be about 6.32 per cent.
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