WHEN YOU BUY A BOND, the best guide to your likely return is the yield—but it isn’t always. Why not? There are two potential issues. First, a high yield is often a sign that the bond’s issuer is in shaky financial condition and could default on its interest payments. This is the big concern with high-yield junk bonds, discussed later in this chapter.
But even if the issuer is in fine financial shape, the yield you’re quoted may be deceptive. That brings us to the second problem: A bond may be trading above its par value, which is usually set at $1,000. That means that at maturity you’ll receive less for the bond than its current price. You often end up with bonds trading above their par value when the general level of interest rates falls, driving up the price of existing bonds that pay more interest. To get a handle on how a lower value at maturity affects the true yield that you earn, try playing around with the simple bond yield calculator offered by MoneyChimp.com.
An added complication: A bond’s maturity date may turn out to be earlier than you expect, because the bond has a “call provision” that allows the issuer to call in the bond early and thus pay off investors before maturity. That means that a bond, which you had hoped would kick off fat interest payments for many years, is suddenly gone from your portfolio. To help investors understand these various risks, bonds are often quoted with a variety of different yields:
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