# Yield Basis: What it Means, How it Works

## What Is Yield Basis?

The yield basis is a method of quoting the price of a [fixed-income security](https://www.investopedia.com/terms/f/fixed-incomesecurity.asp) as a yield percentage, rather than as a dollar value. This allows bonds with varying characteristics to be easily compared. The yield basis is calculated by dividing the coupon amount paid annually by the [bond](https://www.investopedia.com/terms/b/bond.asp) purchase price.

### Key Takeaways

*   The yield basis method quotes the price of a fixed-income security (such as a bond) as a yield percentage instead of a dollar value.
*   The yield basis method helps bond buyers easily compare the characteristics of various bonds before making a purchase.
*   The yield quote tells the bond trader whether the bond is currently trading at a discount or premium compared to other bonds.
*   Purchasing a bond on a net yield basis means the yield also includes the broker's profit or markup for executing the trade.

## Understanding Yield Basis

Unlike stocks, which are quoted in dollars, most bonds are quoted with a yield basis. For example, assume a company is listed with a 6.75% [coupon rate](https://www.investopedia.com/terms/c/coupon-rate.asp) and is set to mature 10 years from the date of issuance. The $1,000 par bond is trading at a dollar value of $940.

The yield basis can be calculated using the [current yield](https://www.investopedia.com/terms/c/currentyield.asp) formula presented as:

> Coupon / Purchase Price

Following our example above, the coupon to be paid annually is 6.75% x $1,000 = $67.50. Therefore, the yield basis is $67.50 / $940 = 0.0718, or 7.18%. The bond will be quoted to investors as having a yield basis of 7.18%.

The yield quote tells a bond trader that the bond is currently trading [at a discount](https://www.investopedia.com/terms/a/at-a-discount.asp) because its yield basis is greater than its coupon rate (6.75%). If the yield basis is less than the coupon rate, this would indicate that the bond is trading [at a premium](https://www.investopedia.com/terms/a/at-a-premium.asp) since a higher coupon rate increases the value of the bond in the markets. A bond trader could then compare the bond to others within a certain industry.

## Bank Discount Yield

The yield basis of a pure discount instrument can be calculated using the [bank discount yield](https://www.investopedia.com/terms/b/bankdiscountbasis.asp) formula, which is:

> r = (Discount / Par Value) x (360/t) where  
> r = Annualized yield  
> Discount = Par value minus purchase price  
> t = time left to maturity  
> 360 = Bank convention for the number of days in a year

Unlike the current yield, the bank discount yield takes the discount [value from par](https://www.investopedia.com/terms/p/parvalue.asp) and expresses it as a fraction of the par value, not the current price, of the bond. This method of calculating the yield basis assumes simple interest; that is, no compounding effect is factored in. [Treasury bills](https://www.investopedia.com/terms/t/treasurybill.asp) are [quoted only on a bank discount basis](https://www.investopedia.com/articles/investing/042815/how-read-tbill-quote.asp).

For example, assume a Treasury bill with a $1,000 face value is selling for $970. If its time to maturity is 180 days, the yield basis will be:

> r = \[($1,000 - $970)/$1,000\] x (360/180)  
> r = ($30/$1,000) x 2  
> r = 0.06 or 6%

As Treasury bills pay no coupon, the bondholder will earn a dollar return equal to the discount if the bond is held until it matures.

## Special Considerations

When purchasing bonds, it's important for the investor to understand the difference between the yield basis and the net yield basis. On the [secondary market](https://www.investopedia.com/terms/s/secondarymarket.asp), you can purchase bonds through a broker/dealer, who could charge you a flat commission for this service. However, in lieu of a commission, your broker may opt to sell bonds on a net yield basis.

Net yield means the yield also includes the broker's profit for the transaction. This is the broker's [markup](https://www.investopedia.com/terms/m/markup.asp), which is the difference between what the broker paid for the bonds and what the [broker sells](https://www.investopedia.com/ask/answers/03/091903.asp) them for. If a broker offers bonds on a net yield basis, they've already included their markup. For example, if an online broker sells you a bond with a 3.75% [yield to maturity (YTM)](https://www.investopedia.com/terms/y/yieldtomaturity.asp), their profit is embedded directly in the price you pay and there is no separate commission.

When comparing various bonds for a possible purchase, bond buyers should ask their broker if the bonds are on a net yield basis or if they charge a separate commission to execute the trade. Brokers might charge other fees, such as a broker-assisted fee for transactions not conducted online. Your overall cost for the trade may also include [accrued interest](https://www.investopedia.com/terms/a/accruedinterest.asp), which is the interest accrued on the bond between the last payment and the settlement date.

> **Article Sources**
>
> 1.  Financial Industry Regulatory Authority. "[Bonds: Key Terms](https://www.finra.org/investors/investing/investment-products/bonds#key-terms)."
>     
> 2.  Financial Industry Regulatory Authority. "[Bonds: Buying and Selling](https://www.finra.org/investors/investing/investment-products/bonds#buying-and-selling)."
>     
> 3.  TreasuryDirect. "[Treasury Bills In Depth](https://www.treasurydirect.gov/research-center/history-of-marketable-securities/bills/t-bills-indepth/)."