What is a bond's yield, and how is it different from the coupon?

What does "yield" mean for a bond?#

In everyday use, yield is the return a bond gives you for the price you pay. The St. Louis Fed describes bond yield as the average return from owning a bond, which depends on the price paid, the coupon payments and the time to maturity^[1]. Investor.gov's glossary gives the simplest version: the annual rate of return calculated by dividing the coupon interest by the purchase price^[2].

The key word is price. A bond's coupon is fixed in dollars, but its price changes every day it trades. FINRA puts the rule in one line: price and yield are inversely related — as a bond's price goes up its yield goes down, and vice versa^[3]. Our note on why bond prices fall when rates rise explains what moves the price in the first place.

How are the coupon rate, current yield and yield to maturity different?#

Coupon rate. FINRA describes it as the annual interest rate set when the bond is issued, which does not change during the bond's life^[3]. A $1,000 bond with a 5% coupon pays $50 a year, whatever happens to its price. See our glossary entry on the coupon.

Current yield. Investor.gov defines it as the ratio of the interest payable on a bond to its actual market price, stated as a percentage^[5]. FINRA's example: a $1,000 bond paying $45 a year has a 4.5% coupon yield, but if its price rises to $1,030 the current yield falls to 4.37%^[3].

Yield to maturity. The SEC calls it a widely used measure for comparing bonds: the annual return if the bond is held to maturity, taking into account when you bought it and what you paid^[4]. FINRA describes it as the overall interest rate earned by someone who buys at the market price and holds until maturity^[3].

What do the yields look like with real numbers?#

Take one bond — $1,000 face value, 5% coupon paid twice a year, eight years left — and price it three ways. The coupon never changes. The yields do.

A bond priced above its face value is said to sell at a premium, as Investor.gov's glossary puts it^[6]; below face value it sells at a discount. You can test other prices with our bond yield calculator.

What are yield to call and yield to worst?#

Some bonds let the issuer repay early — a call. The SEC explains that the terms of some bonds give the company the right to buy back the bond before the maturity date, which is known as calling the bond^[7]. If that happens, the yield to maturity you were quoted never arrives.

FINRA explains that yield to call is worked out the same way as yield to maturity, except that you use the call date and the call price instead of the maturity date; yield to worst is whichever of the two is lower^[3]. In our example, if the 5% bond bought at $1,050 could be called at $1,000 after three years, its yield to call would be 3.24% — well below its 4.26% yield to maturity. Its yield to worst is therefore 3.24%.

Which yield should a beginner compare?#

For comparing two bonds you plan to hold, yield to maturity is the usual starting point because it includes both the coupons and the price gap^[4]. For a callable bond, check the yield to worst as well. For income planning, current yield tells you what cash the bond pays this year relative to its price.

1. 1

   Check the price against face value

   Below $1,000 per $1,000 of face value means a discount; above means a premium.

2. 2

   Read the yield to maturity

   It folds the coupons and the gain or loss at maturity into one yearly rate.

3. 3

   Check whether the bond is callable

   If so, compare yield to call and use the lower of the two — the yield to worst.

4. 4

   Ask why the yield is high

   Lower-rated bonds generally pay more to compensate for greater risk^[8]. Look at the credit rating and the maturity date.

A higher yield is not free. Investor.gov notes that non-investment-grade bonds generally offer higher interest rates to compensate investors for greater risk^[8]. Before comparing yields, make sure you are comparing bonds of similar credit quality and maturity.

How do yields connect to the wider bond market?#

Because yield moves opposite to price, "yields rising" and "bond prices falling" describe the same move. The IMF's Finance & Development magazine illustrates the same inverse link: when the return investors can get elsewhere rises, they pay less for a bond with the same payments^[9].

Plotting the yields of bonds with different maturities gives a yield curve, which Investor.gov describes as a line graph of yields over maturities from three months to 30 years, used to evaluate bond markets and interest rate expectations^[10]. Our note on the yield curve explains how to read it, and Treasury bills, notes and bonds shows recent Treasury yields by maturity.

What mistakes do beginners make?#

1. Treating the coupon as the return

   The coupon is only your yield if you pay exactly face value. At any other price, check the current yield and the yield to maturity.

2. Ignoring the loss built into a premium bond

   If you pay $1,050 for a bond that repays $1,000, that $50 shortfall is part of your return. Current yield hides it; yield to maturity includes it.

3. Forgetting about calls

   A callable bond's yield to maturity may never happen. Look for the call date and use the yield to worst.

4. Chasing the highest yield

   A yield far above similar bonds is a signal to look harder at credit risk, not a free extra return.