Exemplar Prep
Lesson · 7 min read + 5 checks

Coupon, current yield and yield to maturity

All lessons

Show full lesson

A fixed-coupon bond has three useful yield measures. Learn what each includes, then use price and par to order them.

The ruleCurrent yield = annual interest in dollars ÷ market price. For the plain positive fixed-coupon case: discount, coupon < CY < YTM; premium, coupon > CY > YTM.

Three answers to three different questions

Use a plain fixed-rate bond with a positive coupon, regular payments and repayment at par. Exclude accrued interest, taxes and fees. Assume the issuer pays as promised and the bond is held to maturity without an early call. Floating-rate and zero-coupon bonds do not fit every ordering below.

Keep reading: 5 more paragraphs (about 1 min)

Coupon rate = annual interest in dollars ÷ par value. A fixed 5% coupon on $1,000 par pays $50 a year if the issuer pays as promised. A change in market price does not reset that coupon.

Current yield = annual interest in dollars ÷ market price. At $900, $50 ÷ $900 = 5.56%. At $1,100, $50 ÷ $1,100 = 4.55%. This measures coupon income relative to price. It excludes a gain or loss at maturity and income from reinvesting coupons.

Yield to maturity (YTM) is the annual yield implied by the price and all promised payments through maturity. It includes coupons and repayment at par. Paying $900 and receiving $1,000 adds a gain; paying $1,100 and receiving $1,000 creates a loss. YTM is an estimate, not a guarantee of the investor’s actual return.

For this plain positive-coupon case: discount means coupon rate < current yield < YTM; par means all three are equal; premium means coupon rate > current yield > YTM. Learn this order and current-yield arithmetic. An exact YTM formula is not needed here.

Rate changes are often quoted in basis points. A basis point is one hundredth of a percentage point, or 0.01%, so 100 basis points equal one percentage point. A move in yield from 4.25% to 4.85% is 0.60 percentage points, which is 60 basis points. Because bond prices and market yields move in opposite directions, a 60-basis-point rise in market yields means the price of an existing fixed-rate bond has fallen.

Exam terms (6)
Nominal (coupon) yield
Annual interest in dollars divided by par; fixed for a fixed-rate bond.
Current yield
Annual interest in dollars divided by current market price.
Yield to maturity
Annual yield implied by price and all promised coupon and principal payments through maturity.
Pull to par
The gain or loss from repayment at par, assuming the issuer pays as promised.
Discount bond
A bond priced below par. With a positive fixed coupon, current yield exceeds the coupon rate.
Premium bond
A bond priced above par. With a positive fixed coupon, current yield is below the coupon rate.

Which yield is highest depends on where the price sits

Discount pricePremium price
  1. Below par: YTM highest
  2. At par: all three equal
  3. Above par: coupon highest
For the plain positive fixed-coupon case above, current yield lies between coupon rate and YTM.

Try it: A plain non-callable bond has $1,000 par, a fixed 6% coupon and a clean quote of 95 ($950). On paper, find current yield to two decimal places and decide whether YTM is higher or lower. Check: annual interest is $60; $60 ÷ $950 = 6.32%. YTM is higher because repayment at $1,000 adds a $50 gain if promised payments occur.

Check yourself

Try a question, then read the explanation to review the rule.

Opening your study record…

Worked example

Kenji considers a plain non-callable Farthing Cement bond: $1,000 par, a fixed 5% coupon, 10 years to maturity and a clean price of $1,100. Assume promised payments occur.

  1. Annual interest is 5% × $1,000 = $50. The fixed coupon does not change with price.
  2. Current yield is $50 ÷ $1,100 = 4.55%. It is below the coupon because the buyer pays more than par for the same $50.
  3. If the issuer makes the promised payments, the buyer receives $1,000 at maturity after paying $1,100. That $100 loss makes YTM lower than current yield.
  4. State the relationship without a YTM formula: 5% coupon > 4.55% current yield > YTM. Current yield measures income relative to price; YTM also reflects repayment at par.

Same rule, new context

Opening your study record…

The closest contrast

Current yield ignores the pull to par.

YTM includes it.

For the plain fixed-coupon case, a buyer below par gains at maturity and a buyer above par loses at maturity if the issuer pays. Current yield leaves out that price-to-par change.

Summary

  • Coupon rate uses annual interest in dollars ÷ par. Current yield uses annual interest in dollars ÷ market price.
  • YTM includes promised coupons and repayment at par. Actual return can differ.
  • For a plain positive fixed coupon: discount, coupon < CY < YTM; par, equal; premium, coupon > CY > YTM.
  • A zero-coupon bond has a zero coupon rate and zero current yield. Do not apply the strict three-yield ordering to it.

Related practice

Sources

Your study day