Reading a bond's real yield
A bond's coupon rate is fixed at issue, but the return you actually earn depends on the price you pay. Buy below face value (a discount) and your return exceeds the coupon; pay above face (a premium) and it falls short. The yield to maturity (YTM) captures the whole picture: every coupon plus the gain or loss between your purchase price and the face value you receive at maturity, expressed as an annual rate. The current yield is a simpler, less complete snapshot.
The YTM formula
Price = Σ C/(1+r)t + F/(1+r)n
For semi-annual bonds, C is the half-year coupon (face × coupon% ÷ 2), r is the per-period yield, t runs over the periods, and n is years × 2. Because r appears on both sides, YTM is found by solving numerically (this calculator uses a bisection search). Current yield is simply annual coupon ÷ price.
Worked example
A bond with $1,000 face value, a 5% coupon and 10 years left pays $50/year ($25 semi-annually). If the market price is $950 (a discount), the current yield is 50 ÷ 950 ≈ 5.26%. The YTM is higher — about 5.8% — because you also pocket a $50 capital gain at maturity. Had you paid $1,050 (premium), the YTM would drop below 5% as the loss offsets coupons.
Current yield vs YTM
Current yield ignores the maturity gain or loss, so it is only accurate when price equals face value. YTM is the figure to compare across bonds, because it puts discount, premium and coupon schedule on the same footing. Always compare YTMs, not coupons, when choosing between bonds.
5 tips for bond buyers
- Compare YTM, not coupon. The coupon is historical; YTM is what you earn from today's price.
- Mind the frequency. Semi-annual compounding lifts YTM a touch versus annual; keep it consistent when comparing.
- Watch duration. Longer maturity means more price sensitivity to rate moves, even at the same YTM.
- Check for call risk. A callable bond may be redeemed early, cutting your real yield below YTM.
- Use credit ratings. A very high YTM often signals higher default risk, not a free lunch.
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