Bond Yield vs. Equity
Original post by Geri Terzo of Demand Media
A bond yield is the return that an investor earns in the debt markets. It is based on the interest rate that the bond pays as well as the face value, or principal amount, of the debt security. Equity returns are the profits that investors earn in the stock market. These returns can be unpredictable, but stocks have the potential for greater rewards in comparison with traditional bond yields.
Bond yields are distributed through regular interest payment throughout the year. Investors are also reimbursed for the face value of a contract when the bond matures, or expires. Bond yields can be fixed, and subsequently investors understand at the onset of the contract the types of returns that will be earned over time. There are fewer absolutes in the equity markets. After purchasing a stock for the market value of the security, performance in that equity security could increase or decrease in response to many factors.
Historically, bond yields and equity returns are not correlated. Investors often gain exposure to both asset classes for the diversity these categories provide. As of the time of publication, however, the equity markets and bond yields are both advancing, which is threatening to trouble the markets, according to "The Wall Street Journal." Higher bond yields increase the borrowing costs for corporations, which in turn can diminish profitability. Weaker profits typically translate into lower returns in the equity markets.
The bond yields for floating-rate bonds are less predictable than fixed-rate debt securities. This is because the interest rate on a floating-rate bond is subject to change each month or quarter in response to bond market rates. Investors benefit if market rates rise because it increases a bond's yield, but falling rates lead to lower yields. Equity returns are unpredictable for different reasons. Supply and demand drives the market price of a stock higher and lower, and returns change throughout the course of a trading session.
Investors could get the benefits of both bond and equity investments in one security. A convertible bond is a financial security that may eventually be transformed into an equity share unless an investor decides to sell it first. The convertible bond pays investors interest distributions, and so the income stability from the bond yield remains. However, the promise of equity-like returns is also available. An investor may choose to convert the security to an equity share and subsequently earn the profits that are generated in the stock market.
- MarketWatch; Reach For Yield Doesn't Mean Taking More Chances; Murray Coleman; April 2007
- MarketWatch: Bonds -- Convertible Bonds
About the Author
Geri Terzo is a business writer with over 15 years experience reporting on Wall Street. Her coverage ranges from institutional investing, including hedge funds and investment banking, to family topics and her career experience includes work for Fox Business, CNBC and "IDD Magazine." Terzo is a graduate of Campbell University, where she earned a B.A. in mass communication.