Bonds & Interest Rates · Intermediate · 5 min

Yield vs. coupon (yield to maturity)

You can tell the coupon from the current yield and the yield to maturity, and estimate the yield of a bond bought below or above face value.

4% coupon, 5.2% yield?

A bond pays a coupon of 4%. A financial website says it yields 5.2%. Both are correct.

The difference confuses many beginners, but it is essential for comparing bonds. The coupon tells you what the bond pays on its face value. The yield tells you what you earn on the money you actually put in. This lesson explains three measures and when to use which.

Coupon, current, YTM

Three numbers describe what a bond pays:

Coupon: the fixed interest on the face value. It is written at issue and does not change.
Current yield: the current yield divides the yearly coupon by today's market price. If you pay less than face value, it is higher than the coupon. If you pay more, it is lower.
Yield to maturity: the yield to maturity, or YTM, is the return you earn if you buy at today's price, hold until maturity and receive every payment on time. It includes all coupons and the gain or loss from the purchase price to the face value, spread over the remaining years.

FINRA describes the yield to maturity as the overall interest rate earned by an investor who buys at the market price and holds until maturity. Because it includes both income and the move towards face value, it is the usual measure for comparing bonds, and bond yields in the news usually mean it.

The connection to the last lesson: when market rates rise, the prices of existing bonds fall until their yield to maturity matches the new rates. Price and yield are two sides of the same thing. A falling price means a rising yield.

The yield to maturity has limits. It assumes the issuer pays in full and on time. A very high yield often means the market doubts that. It also assumes you hold to the end. Sell earlier, and your return depends on the price at that time.

YTM ≈ 5.2%

A fictional bond has a face value of 1,000, a 4% coupon and five years left. It trades at 950.

Coupon: 4% of 1,000 = 40 a year.
Current yield: 40 ÷ 950 ≈ 4.2%.
Yield to maturity: the buyer receives 40 a year plus a gain of 50 at maturity. Spread over five years and compounded, that comes to about 5.2% a year.

If the same bond traded at 1,050 instead, the buyer would lose 50 by maturity, and the yield to maturity would fall to about 2.9%, below the coupon.

Common mistakes

Comparing bonds by coupon. Compare by yield to maturity.
Ignoring the price paid. Paying above face value means a loss at maturity.
Treating a high yield as a bargain. It often signals high credit risk.
Forgetting the assumptions. The YTM holds only if you keep the bond and all payments arrive.

The takeaway

The coupon is fixed on face value. The yield to maturity also counts the price you pay and the gain or loss to face value at the end.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the measure that includes the gain from the purchase price up to face value.

Tap the chart.

The yield to maturity counts coupons and the 50 gain from 950 to 1,000, spread over the remaining years.
2A bond with a 4% coupon trades at 950. What is its current yield?

Current yield = yearly coupon ÷ price: 40 ÷ 950 ≈ 4.2%.
3A bond trades above its face value. How does its yield to maturity compare with its coupon?

Paying more than face value means a loss at maturity, which pulls the yield below the coupon.
4What does the yield to maturity assume?

It is the return if all payments arrive as promised and you hold until the end.

of 4 correct.