How to Calculate Realized Return on a Defaulted Bond

by C. Taylor

A bond pays investors regular coupon payments until the bond matures. Upon maturity, the bond issuer pays its regular coupon payment in addition to the bond's face value. A defaulted bond typically occurs when an issuing company is in poor financial health or goes bankrupt. When this occurs, the investor receives less than the agreed-upon payments or none at all. The realized return on a defaulted bond calculates the total amount received with respect to the original investment. This realized "holding period" return may be further annualized to calculate the realized annual return.

Realized Holding Period Return

Add all payments received from the bond, including all coupon payments and any distribution offered during bankruptcy or litigation. As an example, if the issuer made four coupon payments of $20 before going bankrupt and distributing $150 to each bond investor, the total amount received is $80 in coupons plus $150 in distribution, which totals $230.

Divide the total amount received by your original investment. If you purchased the bond for $1,000, divide $230 by $1,000 to equal 0.23.

Subtract 1 from this result to calculate your realized holding period return. In the example, 0.23 minus 1 calculates the realized return of -0.77, or -77 percent. Because the return is a negative number, you know you had a loss.

Realized Annual Return

Divide the total amount received by the original investment amount. In the previous example, dividing $230 by $1,000 gives you the same 0.23 figure as before.

Raise this figure to the power of 1 divided by the number of periods. The example had four payment periods, so you raise 0.23 to the power of 1/4 to calculate 0.6925.

Subtract 1 from this figure to calculate the realized annual return. In the example, this results in a realized annual return of -0.3075, or -30.75 percent.