Coupon Rate vs Yield Rate for Bonds
Hi guys, what would be the difference between yield and coupon rates? I always thought that coupon rates were yearly return rates and yield was the lifetime return but is this wrong?
Bond Coupon vs. Bond Yield
Technical terms surrounding bonds are numerous and can sometimes be confusing. Below we have defined the terms surrounding the different bond yields.
Coupon Rate on Bonds Definition
The coupon rate of a bond represents the amount of actual interest that is paid out on a bond relative to the principal value of the bond (par value). Finding the coupon rate is as simple as dividing the coupon payment during each period divided by the par value of the bond. This is often referred to as the stated rate.
Bond Yields Explained
The term bond yield can reference several different metrics - most notably the yield to maturity formula and the current yield calculation.
Bond Yield to Maturity Formula
A bond's yield to maturity estimates the bond's overall return assuming that the bond is held to maturity. It is often thought of as the effective rate of return. Overall, it accounts for the capital gains (or losses) that occur when you buy a bond at a discount or pay a premium to par as well as the interest payments that are collected.
It can equal the coupon rate when the current value of the bond is equal to the par value of the bond.
Bond Current Yield Calculation
The current yield looks at the annual interest payment / current bond price. This calculation is used to give an approximate look at the return on a bond if you were to hold it for a year.
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Yield can be different than coupon rates based on the principal price of the bond. If the price is par at time of purchase and you receive par at maturity, then the yield and coupon will be the same.
For instance, say a bond at issuance is priced at 100 with 10% coupons. You pay 100 initially and receive 10% coupons over the life of the bond. At maturity, you receive 100. The yield and coupon will both equal 10%.
However, if you buy at a discount, say at 90 instead of 100, and receive 100 at maturity, all the while still receiving 10 (10% on principal of 100), your yield will be greater than 10%.
If by Yield you mean Yield to Maturity, then it is the discount rate on the bond's cash flows.
Bond Price = NPV of the CF's of the Bond = (Face Value)(Coupon Rate)/(1 + YTM) + (Face Value)(Coupon Rate)/(1 + YTM)^2 + ... + [(Face Value)*(Coupon Rate) + Face Value]/(1 + YTM)^n, where n is maturity for the bond.
Since interest rates (discount rates) for each period aren't necessarily the same, if you have the bond price, the face value, coupon rate, and actual interest rates for each period, you can solve for the YTM, which is like an average of the discount rates used to price the bond.
As stated above,
Coupon Rate is almost always constant; meaning whatever the coupon rate is at issuance is almost always going to be the coupon rate. There are times when the coupon rate isn't always constant (such as floating rates), but for this case it's easy to think of it as constant so you can distinguish it from yield.
Yield is measured a bunch of different ways.
1) Current Yield: Calculates the % return of the annual coupon payment. Current yield takes into account the movement away from par value. Current Yield doesn't take into account time value of money.
2) YTM (Yield to Maturity): Interest rate by which the present value of all future cash flows are equal to the bond's price. There are a bunch of assumptions that go into calculating YTM, and the formula is generally a trial-and-error thing. In any event, when someone says "yield" and they are referring to a bond they generally mean YTM.
For more reading on YTM just Google it.
yield's, prices and coupon relationship from investors'point of view (Originally Posted: 10/19/2010)
ok, i know the relationship between yields, prices and coupons, but what im confused with is depending on whether your the corporate borrower or the investor, those measures could mean different things. i know that if yields are low, companies can finance with cheaper loans in the form of lower interest payments. but if the cooupon of the same underlying bond is relatively high, what does it mean?
and what about from the investor's point of view? why is it that they, for example, they move funds to emerging markets where interest rates, and therefore yields, are more attractive but coupons could be low?
can someone please clarify that for me?
thanks!
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