Two key features of a convertible are its current yield and its yield to maturity. The current yield indicates the yield of the security based on its current market value. It is calculated by dividing the annual interest payment by the market price. For example, the current yield of a bond with a 5% coupon selling at $875.00 would be 5.7% {($50/$875) x 100}. This does not take into account the total return over the life of the bond, nor does it consider reinvestment.

The yield to maturity of a bond is the interest rate (compounded) that would equate interest and principal payments to be received in the future relative to the present cost. *The Value Line Convertibles Survey* calculates the yield to maturity for each and every bond included in its evaluation process, and provides that number on its website.

Take the AmeriCredit 2.125% convertible note due in 2013 as an example. Recently priced at 95.893, it pays interest semi-annually and matures on September 15, 2013. Calculating the bond’s current yield is easy. Just divide its annual payout (interest) by the price paid. In this case, the AmeriCredit annual coupon (2.125%) equates to interest payment of $21.25 annually. Its market price is $958.93. Therefore, dividing $21.25 by $958.93 equals 2.2%. Calculating the bond’s yield to maturity is more complicated. It takes into account all aspects of your investment: the coupon, capital gains or losses, and the discounted future value of money.

Using the equation, we can calculate the value of “r”.

P = C/(1+r)y + C/(1+r)y + C/(1+r)y +…. + B/(1+r)y

Where

P = purchase price

B = par value

C = annual coupon payment ($)

r = yield to maturity

y = number of years to maturity

I n this scenario, we are looking to find the yield to maturity, or “r”. Using the above example, we plug the available numbers into the formula. That is,

958.93 = 21.25/(1+r) + 21.25/(1 + r)2 + 21.25/(1 + r)3 + 1000/(1 + r)3

Using a computer, we solve for r, which in this case, equals approximately 3.6%.

There is a relationship between current yield, yield to maturity, and coupon rate that investors need to consider.

1. If a bond is selling below par, its yield to maturity will be greater than its current yield, which in turn will be more than the coupon rate.

2. If a bond trades at a premium, its coupon rate will be greater than its current yield, which will be more than its yield to maturity.

3. If a bond trades at par, its yield to maturity will be equal to both the current yield and the coupon rate.

There are, however, some important variants of yield to maturity to keep in mind.

• Yield to call: when a bond is callable, the yield to call becomes an important calculation. The yield to call is calculated the same way as the yield to maturity, only that the life of the bond to the call date.

• Yield to put: when a bond is putable, holders can force the issuing company to repurchase the debt at a fixed price on a preset date, which is usually far before maturity. The yield to put is calculated the same way as the yield to call, but uses the put date as the terminal date.

• Yield to worst: when a bond is callable, putable, exchangeable, or has other features, the yield to worst is the lowest of all the yields, and uses the nearest end date.