Bond Yield Explained

A single bond can carry an 8% coupon, a 9% current yield, and a 10% yield to maturity, all at once. Those aren't three interest payments — they're three different ways of describing the same bond's economics, and confusing them is one of the most common mistakes in fixed income. The clearest way through is to fix one bond and watch what happens as only its price changes.

One bond, changing price

The annual coupon is fixed by contract: ₹1,000 × 8% = ₹80, paid every year no matter what happens to the bond's market price. The question this whole article answers is: does your actual return change if you pay a different price for those same ₹80-a-year payments? Yes — and understanding exactly how is the point.

Coupon rate: what the bond promises

The coupon rate is the contractual rate applied to face value, not to whatever you paid:

Coupon rate tells you the bond's contractual payment. It does not tell you the return on the price you actually paid.

If the bond's market price falls from ₹1,000 to ₹900 tomorrow, the issuer doesn't quietly change the coupon to ₹72. The contract still says 8% of ₹1,000, so you still receive exactly ₹80. Market price and coupon payment move completely independently of each other — and that single fact is responsible for most of what follows.

Current yield: income relative to today's price

Now suppose you buy that same ₹1,000-face bond for ₹900 instead of ₹1,000. You still receive ₹80 a year. So a simple yield measure naturally suggests itself:

At a ₹900 purchase price: 80 ÷ 900 = 8.89%. The coupon never changed — only the price you paid for the same ₹80 changed, and current yield moved with it:

Why current yield is incomplete

Buy the bond at ₹900 and you don't get ₹900 back at maturity — you get the full ₹1,000 face value, assuming the issuer pays as promised. That's a potential ₹100 gain that current yield completely ignores, because it only looks at annual income relative to price, never at what happens between now and maturity. That gap is exactly what yield to maturity is built to capture.

Yield to maturity: the complete picture

YTM is the single annualized rate that makes the present value of all the bond's remaining cash flows equal its current price, assuming the bond is held to maturity and the issuer pays as promised.

More intuitively: YTM tries to capture both the coupon income and the gain or loss from buying at a price different from face value. Buy below face value and YTM comes out above the coupon rate. Buy above face value and YTM comes out below it.

All three, side by side

Keep the bond identical — ₹1,000 face, 8% coupon, 5 years — and vary only the price you pay:

The pattern holds throughout: as price falls, both yields rise, but YTM always moves further than current yield, because YTM is picking up the capital gain or loss on top of the coupon income that current yield alone measures.

Why YTM is really a present-value calculation

Recall the pricing formula from the previous article: given a yield, you can compute a price. YTM is that same relationship run in reverse — given the price, solve for the yield that makes it consistent with the bond's cash flows.

They are, mathematically, inverse problems using the exact same equation. This is why the calculator's Solve YTM from price and Solve price from YTM modes are really just two directions through one formula.

YTM is not a guaranteed return

That third assumption — reinvestment — is worth sitting with for a moment, because it's the honest caveat underlying every YTM figure this calculator produces. If you buy a bond at 8% YTM and rates later fall, your coupons get reinvested at lower rates than assumed, and your realised compound return ends up below 8%, even if the issuer pays every rupee exactly on schedule.

A clean case: zero-coupon bonds

Zero-coupon bonds make the yield-vs-return distinction unusually clear, because there's no coupon income to muddy the picture. Suppose a bond has ₹1,000 face value, 5 years to maturity, and currently trades at ₹700. There's no annual payment at all — your entire return comes from the price rising from ₹700 to ₹1,000 over five years.

Current yield, as traditionally defined, isn't meaningful here — there's no coupon to divide by price. YTM is the only measure that makes sense for a zero, and it comes entirely from the gap between purchase price and redemption value.

Note: the calculator shows about 7.3899% rather than 7.3941%, because it counts the exact 1,826 calendar days to maturity — which spans a leap day — rather than assuming a clean 5.0-year period. See why the calculator prices this way.

A note on semiannual coupons

Everything above used annual coupons for clarity, but most real bonds pay semiannually — half the annual coupon, twice a year, rather than the full amount once. A 8% annual-rate bond on ₹1,000 face pays ₹40 every six months rather than ₹80 once a year. This changes the YTM calculation: the number of periods doubles, the coupon per period halves, and the compounding convention needs to be applied consistently. It's exactly why the calculator asks for coupon frequency explicitly rather than assuming one — hiding that choice would silently produce a wrong number for the majority of real bonds.

A warning about comparing YTMs

Never assume two bonds both quoted at "8% YTM" are economically equivalent. YTM compresses an entire cash-flow structure into one number, and in doing so it can hide meaningful differences in:

• Credit risk — a corporate bond's 8% and a government bond's 8% carry very different default risk.
• Maturity and duration — two bonds at the same YTM can have very different interest-rate sensitivity.
• Embedded options — a callable bond's YTM doesn't account for the issuer's right to redeem early, which is exactly why yield to call and yield to worst exist as separate measures.
• Liquidity, tax treatment, and seniority in the issuer's capital structure.

Common mistakes