Calculating Bond returns as an annual compounded rate

Question

I've been reading up on bonds and the different methods there are of calculating the yield of the bond. So suppose I bought a $1000 face value with a 5% coupon that pays semi annually for $995 with a maturity of 5 years. after those 5 years I should expect a return of $1500 from my original investment of $995 which translates to approximately 8.6% compounded annually. Would this be a correct method of evaluating the bonds return? And if so could this method be used to compare different bonds?

Answer 1

Would this be a correct method of evaluating the bonds return?

Yes that would the the correct way to calculate return. Note that return and yield are calculated differently (yield to maturity is more complex because it assumes that coupons are reinvested) but they are both measures of the expected income realtive to the original purchase price.

And if so could this method be used to compare different bonds?

You need to understand why bonds have different returns. The other main factors are the length of the bond and the default risk. Longer-dated bonds tend to have greater returns to compensate for having the money tied up for a longer time period, and bonds issued by entities with a greater risk of default have higher returns to compensate for the risk (even slight) that the entity won't be able to make all of the required payments.

So a bond that returns 10% is not necessarily "better" that one that returns 5%. It may mean that the first bond has a significantly higher risk of default.