# Investing in bonds investopedia calculator

- 09.04.2021
- Kazill
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Like the fixed interest rate, the inflation rate is announced twice a year in May and November and is determined by changes to the Consumer Price Index CPI , which is used to gauge inflation in the U. The change in the inflation rate is applied to the bond every six months from the bond's issue date. In effect, the interest paid on Series I bonds is variable and changes over time, making it difficult to forecast the value of the bonds years from today.

How to Calculate Series I Bonds The actual rate on the bond, known as the composite rate , is calculated by combining the fixed and inflation rates. Clearly, the inflation rate impacts the fixed rate set on the bond. However, the minimum level that the interest rate on a Series I bond can fall to is zero, which is the floor placed on the bond by the Treasury. If the inflation rate is so negative that it would take away more than the fixed rate, the composite rate will be set at zero.

Special Considerations Series I bonds are considered low risk since they are backed by the full faith and credit of the U. But with this safety comes a low return, comparable to that of a high-interest savings account or certificate of deposit CD. Corporate and municipal bonds, however, can lose value; with this risk comes a higher return. Series I bonds can be issued in any amount between the minimum and maximum purchase thresholds.

Series I bonds can be held for as little as one year or as long as 30 years, but if they are sold after fewer than five years, the holder sacrifices the last three months' worth of interest. Fast Fact If an I bond is sold and the proceeds are used to pay for higher education, the interest is exempt from federal income tax.

Series I Bonds and Interest Income Interest income for Series I bonds is taxable at the federal level, but not at the state and local levels. The series I bond is a zero-coupon bond , meaning that no interest is paid during the life of the bond. The interest is, instead, added back to the value of the bond and earns interest on interest. The bondholder has the option of selecting one of two methods of taxation—the cash method or the accrual method.

Under the cash method, tax is only applied when the bonds are redeemed. Therefore, a taxpayer that holds a bond for seven years before selling it will only be taxed at the time the bond is sold. Using the accrual method, on the other hand, taxes on the imputed interest earned are applied every year. Sometimes, the Series I bond income is tax-free at the federal level if it is used to pay for higher education. When you sell an I bond and use the proceeds to pay for qualified higher education expenses at an eligible institution in the same calendar year, the interest is exempt from federal income tax.

Treasury, using the TreasuryDirect website. You can also use your federal tax refund to purchase Series I bonds. If you use your income tax refund to purchase U. Hence, the bond trades at a higher amount than its face value, since you are entitled to a higher interest rate than you could get from comparable instruments. A bond is trading at a discount if the price is lower than its face value.

This indicates the bond is paying a lower interest rate than the prevailing interest rate in the market. Since you can obtain a higher interest rate easily by investing in other fixed income securities, there is less demand for a bond with a lower interest rate. A bond with a price at par is trading at its face value—the amount at which the issuer will redeem the bond at maturity.

This is also called the par value. Interest Rate and Yield A bond pays a certain rate of interest at periodic intervals until it matures. Bonds' interest rates, also known as the coupon rate, can be fixed, floating or only payable at maturity. As their name implies, zero-coupon bonds don't pay any interest at all.

Rather, they are sold at steep discounts to their face values. This discount reflects the aggregate sum of all the interest the bond would've paid until maturity. Closely related to a bond's interest rate is its yield. The yield is the effective return earned by the bond, based on the price paid for the bond and the interest it generates. Yield on bonds is generally quoted as basis points bps.

Two types of yield calculations exist. The current yield is the annual return on the total amount paid for the bond. It is calculated by dividing the interest rate by the purchase price. The current yield does not account for the amount you will receive if you hold bond to maturity. The yield-to-maturity YTM is the total amount you will receive by holding the bond until the end of its lifespan The yield to maturity allows for the comparison of different bonds with varying maturities and interest rates.

For bonds that have redemption provisions, there is the yield to call, which calculates the yield until the issuer can call the bond—that is, demand that investors surrender it, in return for a payoff. When interest rates rise, bond prices fall. Conversely, when interest rates fall, bond prices rise. Maturity The maturity of a bond is the future date at which your principal will be repaid. Bonds generally have maturities of anywhere from one to 30 years.

Short-term bonds have maturities of one to five years. Medium-term bonds have maturities of five to 12 years. Long-term bonds have maturities greater than 12 years.

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