Difference Between Coupon vs Yield
A coupon payment on the bond is the annual interest amount paid to the bondholder by the bond issuer at the bond’s issue date until it’s maturity. Coupons are generally measured in terms of coupon rate which is calculated by dividing it with face value. Coupons are paid in two fashion semi-annually and annually in percentage. We also refer to coupon as the “coupon rate”, ”coupon percent rate” and “nominal yield”.
If a bond’s face value of $1000 is paying $70 a year at the rate of 7%, interest payment may be either semiannually or annually. Later, bond’s face value drop down to $900, then it’s current yield rises to 7.8% ($70 / $900).
Usually, the coupon rate does not change, it is a function of the annual payments and the face value and both are constant.
Coupon Rate or Nominal Yield = Annual Payments / Face Value of the Bond
Current Yield = Annual Payments / Market Value of the Bond
Zero Coupon bonds are the only bond in which no interim payments occurs except at maturity along with its face value.
Bond’s price is calculated by considering several other factors including:
- Bond’s face value
- The maturity date.
- The coupon rate and frequency of it are payments.
- Issuer’s creditworthiness.
- The yield on comparable investment options.
Yield to Maturity is the total return an investor will earn by purchasing a bond and holding it until its maturity date. Yield to maturity is a long term bond yield and expresses in terms of an annual rate. In other words, it is the internal rate of return in which the investor holds the bonds until maturity and make all payments as scheduled and simultaneously reinvesting into it at the same rate. Yield to Maturity is also known as a booking yield or redemption yield. The yield to maturity of a bond depends upon the market current price on the bond. However, the yield to maturity formula proves to be a more effective yield of bond based on compounding against the simple yield which is calculated with the help of the dividend yield formula.
Approx YTM = (C + (F-P)/n)*2/(F+P)
- C = Coupon / Interest Payment
- F = Face Value
- P = Price
- n = years to maturity.
The formula is used to calculate the approximate yield to maturity. However, to determine the actual yield to maturity requires to employ trial and error method by putting rates into the present value of a bond formula until P matches the actual price of the bond.
The yield to maturity is calculated by the present value formula discussed below.
For evaluating yield to maturity present value of the bond is already present and calculating YTM is working backward from the present value of a bond formula and trying to determine “r”.
Head To Head Comparison Between Coupon vs Yield (Infographics)
Below is the top 8 difference between Coupon vs Yield
Key Differences Between Coupon vs Yield
Both Coupons vs Yield are popular choices in the market. let us discuss some of the major Difference Between Coupon vs Yield:
- The coupon rate of a bond is the amount of interest that is actually paid on the principal amount of the bond(at par). While yield to maturity defines that it’s an investment which is held till the maturity date and the rate of return it will generate at the maturity date.
- The coupon amount is the amount which is paid out semi-annually or annually till the maturity date on the face value of the bond. While current yield generates the return annually depend on the market price fluctuation.
- Coupon rates are more likely influenced by the interest rates fixed by the government body on the basis country’s economy. While calculating current yield, coupon rate compares to the current market price of the bond.
- During the tenure of the bond, bond price remains same till the maturity due to the continuous fluctuation of the market price, it is better to buy a bond at the discount rate which offers handsome returns on the maturity at face value.
- Coupon amount decides what amount will be paid by the bond on the annual basis or semiannually as per government norms till the maturity while yield defines what will be the returns after reinvestment of coupon amount at the maturity date.
Coupon vs Yield Comparison Table
Below is the 8 topmost comparison between Coupon vs Yield
|1||The coupon amount paid by the bond issuer to bondholder until it’s maturity.||The yield to maturity defines the total return earn by the investor holding it until it’s maturity.|
|2||The rate of interest pays annually.||Current Yield defines the rate of return it generates annually.|
|3||Interest rates influence the coupon rates||Current yield compares the coupon rate to the market price of the bond.|
|4||Coupon amount remains the same until maturity.||Market price keeps on fluctuating, better to buy a bond at a discount which represents a larger share of the purchase price.|
|5||Coupon tells what bond paid when it was issued||The yield or yield to maturity defines how much you will be paid in the future|
|6||Coupon Rate or Nominal Yield = Annual Payments / Face Value of the Bond
|7||The Coupons are fixed; no matter what price the bond trades for.||Yield and prices are inversely related.|
|8||An Investor purchases a bond at its par value, the yield to maturity is equal to the coupon rate.||An investor purchases the bond at a discount, its yield to maturity is always higher than its coupon rate.|
The purpose of this coupon vs yield article is to clear the ambiguity between the yield and the coupon when someone has very limited or no experience of the endless list of the financial industry terms. These two terms coupon vs yield are most commonly encountered while managing or operating in bonds. Moreover, combined usage give better returns and translates into the concept higher coupon rate means higher yield. Apart from the usage in bonds, both terms are quite different from each other.
This has a been a guide to the top difference between Coupon vs Yield. Here we also discuss the Coupon vs Yield key differences with infographics, and comparison table. You may also have a look at the following articles to learn more.