The yield is the return you will receive on a bond, adjusted for its current price. Each bond has a fixed interest rate (known as a coupon), which does not change even when the bond’s price changes in the market. In some cases, bonds are sold at face value or par, and so you receive a return equal to that fixed interest rate. However, if the price of the bond fluctuates, you still receive the same fixed interest payment regardless of the price you paid for the bond.
The yield shows the return you will receive relative to the current price. If the price of the bond rises above its original value, the yield will fall, because you will receive the same fixed interest payment but pay more than the face value for it. If the price of the bond falls below its original value, your yield will rise, because you are receiving the fixed interest payment but paying less than the face value for it.
The city of Neighborly, CA, wants to raise $5 million to convert city hall’s power supply to solar energy. To raise the money it decides to sell $5 million of 5-year bonds, priced at $1,000 each. The Neighborly Solar bonds pay 5% interest, so investors receive $50 per year for the next five years.
Erica buys a Neighborly Solar bond for $1000, its face value. Erica receives $50 interest per year. Erica’s yield is 50 / 1000 = 5%.
Meanwhile, Eduardo buys a Neighborly Solar bond from a broker, but is charged $1100 for it. Like Erica and all other investors, he receives $50 interest per year. Eduardo’s yield is 50 / 1100 = 4.5%.