What is Gross Redemption Yield?

Gross Redemption Yield (GRY) is a measure of the total return that an investor can expect to receive from a bond if it is held to maturity. It takes into account both the income from the coupon payments and the capital gain or loss that the investor will make when the bond is sold.

Calculating Gross Redemption Yield

The GRY is calculated using the following formula:

GRY = (Coupon Payment + Principal) / (Original Principal) * (1 + Yield to Maturity)^-Number of Years to Maturity

• Coupon Payment: The amount of interest that the bond pays to the investor each year.

• Principal: The amount of money that the investor will receive when the bond is redeemed.

• Yield to Maturity (YTM): The interest rate that the investor would earn if they held the bond to maturity and reinvested all of the coupon payments at the same rate.

• Number of Years to Maturity: The number of years until the bond matures.

Interpreting Gross Redemption Yield

The GRY is expressed as an annual percentage rate. A higher GRY indicates that the bond is a more attractive investment because it offers a higher total return.

Relationship between Gross Redemption Yield and Yield to Maturity

The GRY is closely related to the YTM. The GRY will be higher than the YTM if the bond is priced below par value. This is because the investor will receive a capital gain when the bond is redeemed for its face value. Conversely, the GRY will be lower than the YTM if the bond is priced above par value. This is because the investor will have to pay a premium to purchase the bond, and this will reduce their overall return.

Factors Affecting Gross Redemption Yield

The GRY of a bond is affected by a number of factors, including:

• The coupon rate of the bond: The higher the coupon rate, the higher the GRY.

• The creditworthiness of the issuer: Bonds issued by more creditworthy issuers will generally offer lower GRYs.

• The term to maturity of the bond: Longer-term bonds will generally offer higher GRYs.

• The current market interest rates: If interest rates rise, the GRY of existing bonds will fall.

Use of Gross Redemption Yield

The GRY is a useful tool for investors to compare the relative returns of different bonds. It can also be used to assess the attractiveness of a bond investment relative to other types of investments, such as stocks or cash.

Conclusion

The Gross Redemption Yield is a valuable metric for investors who are considering investing in bonds. It provides a comprehensive overview of the total return that an investor can expect to receive from a bond if it is held to maturity. By understanding the GRY, investors can make more informed investment decisions.

Example Question:

Q. An investor is considering buying a bond with a face value of $1,000, a coupon rate of 5%, and a term to maturity of 10 years. The current market price of the bond is $975. What is the GRY of the bond?

Solution:

To calculate the GRY, we need to use the following formula:

GRY = (Coupon Payment + Principal) / (Original Principal) * (1 + Yield to Maturity)^-Number of Years to Maturity

We know the following values:

• Coupon Payment = $50 (5% of $1,000)

• Principal = $1,000

• Current Market Price = $975

• Number of Years to Maturity = 10 years

We need to find the Yield to Maturity (YTM). We can estimate the YTM by using a financial calculator or by looking up bond tables. The YTM is approximately 5.14%.

Now we can plug the values into the formula to calculate the GRY:

GRY = ($50 + $1,000) / ($975) * (1 + 0.0514)^-10

GRY = 10.55%

Therefore, the GRY of the bond is 10.55%. This means that the investor can expect to earn an average annual return of 10.55% if they hold the bond to maturity.