In their most general form, returns refer to profit divided by the corresponding capital investment. Example: If you made a profit of 10 francs on an investment of 100 francs, your return would be 0.1 or 10%.
When dealing with bonds, the return is comprised of the total earnings received when the bond reaches maturity.
A number of factors should be considered:
1) Interest earnings paid out per coupon (which may also be paid out many times per year).
2) Currency rate gains or losses at the time of the sale or repayment of the bond.
3) Possible reinvestments of interest payments to take advantage of compounding interest.
Example of a simplified return calculation
Tenure: 10 years
Face value of the bond: 100 US$
Purchase price: 105 US$ (issuing rate of 105%)
Coupon (annual nominal yield of the bond): 1.5%
Because this example uses a negative interest environment, investors pay US$ 105 for the government bond in question. They get US$ 100 back after 10 years, plus interest of $US 1.50 per year. In this case, the simplified way of calculating returns, not accounting for compounding interest, would be as follows:
Returns on total bond tenure = ((interest + face value)-purchase price) / purchase price)
Returns for total bond tenure = ((US$15 + US$ 100)- US$ 105) / US$ 105 = 0.095 = 9.5%. That comes to an average annual return of approximately 0.95%, which in this case would be below the coupon rate (because a markup was paid when buying the bond).
Get more information:
How do I trade bonds?
What is a coupon?
What is a bond?
Government bonds
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