A bond’s coupon is fixed for life, but its price changes every day, and the price decides the return you actually get. This module explains the seesaw between prices and interest rates, how bond prices are quoted, and the different yields you will see on every quote.
In Module 1 you bought a bond with a 4% coupon. Imagine that a few months later, interest rates rise and new bonds just like yours now pay 5%. You decide to sell. Who would pay full price for a bond that pays $40 a year when they could buy a new one paying $50?
Nobody. To find a buyer, you have to lower the price until your bond offers the same return as the new ones. The lower price makes up for the smaller coupon. That is the whole idea, and it works in both directions:
Example. A five-year bond has $1,000 of face value and a 4% coupon. To keep the arithmetic simple, it pays the coupon once a year, so $40 a year. While market rates for five-year bonds are 4%, it is worth $1,000.
| Market rate for new five-year bonds | Price of your 4% bond | Change |
|---|---|---|
| 3% | about $1,045.80 | +4.6% |
| 4% | $1,000.00 | — |
| 5% | about $956.71 | −4.3% |
Where does $956.71 come from? A buyer of your bond gets $10 a year less than from a new 5% bond, for five years. The price drops by about what those missing payments are worth today: roughly $43. The prices in the table are the value of the remaining payments worked out at the new market rate. You will rarely need to calculate one by hand, but it helps to know where they come from.
Bond prices are quoted per $100 of face value, not in dollars per bond. A price of 100 means the bond trades at exactly its face value.
Accrued interest. When you buy a bond between coupon dates, you also pay the seller the interest it has earned since the last payment, because you will receive the whole next coupon. Example. $10,000 of a 4% bond pays $200 every six months. If you buy it three months after the last payment, you pay about $100 of accrued interest on top of the price, and you get it back with the next $200 coupon. Your broker works this out for you. Just don’t be surprised when the total is a little higher than the quoted price.
The coupon tells you what a bond pays as a percentage of its face value. But you rarely pay exactly the face value. The current yield tells you what it pays as a percentage of the price you pay.
Example. A bond pays $40 a year and costs $950 for $1,000 of face value. The current yield is $40 ÷ $950 = 4.21%, a bit more than the 4% coupon, because you paid less than face value.
Current yield is easy to work out, but it leaves something out. The $950 bond will pay back $1,000 at maturity, so you also gain $50. Current yield ignores that gain. For a premium bond, it ignores the loss.
Yield to maturity (YTM) is the total yearly return you get if you buy at today’s price, hold to maturity, and every payment arrives on time. It counts both the coupons and the move from today’s price back to face value.
Go back to the seesaw example. When rates rose to 5%, your 4% bond fell to about $956.71. A buyer at that price gets three things:
| Measure | What it counts | Value |
|---|---|---|
| Coupon rate | $40 ÷ $1,000 face value | 4.00% |
| Current yield | $40 ÷ $956.71 price | 4.18% |
| Yield to maturity | Coupons plus the $43.29 gain back to $1,000 | 5.00% |
The YTM is exactly the 5% that new bonds pay. That is no coincidence: the price fell until the bond offered the market rate. Two rules follow from this:
The exact YTM takes a calculator, and every bond quote and broker screen shows it for you. If you want to check one, this rough formula gets close:
Check. ($40 + $43.29 ÷ 5) ÷ (($1,000 + $956.71) ÷ 2) = $48.66 ÷ $978.36 ≈ 4.97%, close to the true 5%.
You will see several yields quoted, sometimes side by side, and they can tell very different stories about the same bond.
| Yield | What it tells you | Use it to compare? |
|---|---|---|
| Coupon rate | The interest set when the bond was issued | No: it ignores the price you pay |
| Current yield | This year’s cash income on today’s price | For income only |
| Yield to maturity | Total yearly return if held to maturity | Yes |
| Distribution yield (funds) | Recent payouts divided by the fund’s price | No: covered in Module 8 |
When you compare two bonds, compare YTM with YTM. Make sure they mature around the same time and come from borrowers of similar quality, because a higher YTM is often payment for more risk. Module 4 explains how to tell. A high coupon on its own tells you very little: a premium bond with a 6% coupon can have a lower YTM than a discount bond with a 3% coupon.
Educational purposes only; not financial advice. Any bonds, funds, tickers, rates and figures are illustrative examples, not recommendations. Interest rates, deposit-insurance limits and tax rules change, so confirm current details with the issuer, CDIC and your tax authority. Worked examples are not forecasts. Written by Elizabeta Dimoska. Always do your own research and consult a licensed advisor.