Coupon, Current Yield and Yield to Maturity

Start with the contract and the purchase price

A conventional fixed-rate bond has a face value, a coupon and a maturity date. The issuer promises specified payments under its terms. Those promises depend on its ability to pay and any contractual exceptions.

The secondary-market price can be above or below face value. That difference is why several yield measures can describe the same bond without contradicting each other.

Coupon: payment on face value

In a hypothetical bond with $1,000 face value and a 5% annual coupon, annual coupon payments total $50. Payment frequency is a separate term: two equal instalments would be $25 each.

If you pay $950 or $1,050 for the bond, that conventional fixed coupon remains $50. Floating-rate, inflation-linked and other instruments have different payment rules. Read the terms rather than generalising from the word “bond”.

Current yield: income against today’s price

Current yield divides annual coupon income by price. Using the same hypothetical bond, $50 divided by $950 is about 5.26%; $50 divided by $1,050 is about 4.76%. For this simple illustration, ignore accrued interest, fees and tax.

This measures income relative to the quoted investment amount. It leaves out the difference between purchase price and repayment at maturity.

Yield to maturity: the scheduled cash-flow equation

Yield to maturity is the discount rate that equates the purchase price with the scheduled coupons and maturity repayment. It incorporates the time remaining and any difference between price and face value.

For a one-year hypothetical bond bought immediately after a coupon date for $950, with a single $50 coupon and $1,000 repayment in one year, the scheduled return is ($1,050 − $950) ÷ $950, or about 10.53%. This special example has no interim coupon to reinvest.

For longer bonds, realised compounded return depends on reinvestment rates as well as payments occurring as scheduled. Selling early, default, a call or changing tax circumstances can produce a different result. Yield to maturity is a calculation, not a guarantee.

Cash settlement can exceed the quoted price

Some quotations use a clean price that excludes accrued interest. The settlement amount includes accrued interest under the market’s conventions. Establish what a quote and calculator include before calculating the cash required.

A high coupon may be attractive to someone needing cash flow, while a bond bought above face value can still lose capital at scheduled repayment. Income and total return must be considered together.

What to do with this

For one hypothetical bond, put coupon, purchase price, accrued interest, maturity, repayment amount and yield measure on separate lines. Do not compare its coupon with another investment’s total return.