Current yield vs. yield to maturity: how to read a bond's yield

A bond has a coupon rate printed on it, a current yield quoted by your broker, and a yield to maturity that appears in the fine print — and the three are often different. They are not competing opinions. Each measures something specific, and the gaps between them tell you whether you are buying the bond cheaply or paying extra for it.

Three numbers, three questions

Coupon rate: the interest the bond pays each year as a percentage of its face value — the amount repaid at maturity. A $1,000 bond with a 5% coupon pays $50 a year, often as two payments of $25. The coupon never changes, whatever the bond trades for.

Current yield: the annual coupon divided by the price you pay today. It answers “how much income does this bond pay relative to what it costs me now?”

Yield to maturity (YTM): the total yearly return if you buy at today’s price, collect every coupon, and hold until the bond is repaid at face value. It answers “what will I earn in total, per year, if I keep it to the end?”

A bond bought at a discount

Take a $1,000 bond with a 5% coupon and 10 years left, trading at $950. Its current yield is $50 ÷ $950, or about 5.26% — higher than the coupon, because you pay less than face value for the same $50 of income.

Its yield to maturity is higher still, about 5.66%. On top of the coupons, you will receive $1,000 at maturity for a bond you bought at $950, and that $50 gain, spread over ten years, is part of your return. Current yield ignores it; yield to maturity includes it.

A bond bought at a premium

Now suppose the same bond trades at $1,080. Its current yield is $50 ÷ $1,080, or about 4.63% — below the coupon. Its yield to maturity is lower again, about 4.02%, because you will only get $1,000 back at maturity for a bond you paid $1,080 for. That $80 loss is spread across the remaining years and drags down the total return.

This gives a simple rule. When a bond trades below face value (at a discount), yield to maturity is above current yield, which is above the coupon. When it trades above face value (at a premium), the order reverses. When it trades exactly at face value (at par), all three are equal.

Why bond prices move

A bond’s coupon is fixed, so the only way its yield can keep up with the rest of the market is for its price to change. If new bonds start paying 6%, nobody will pay $1,000 for an old bond paying 5%; its price falls until its yield to maturity matches the market. For our 10-year bond, a 6% market yield implies a price of about $926. If market yields fall to 4%, the price rises to about $1,082.

This is why bond prices and yields always move in opposite directions, and why longer bonds move more. The same one-point rise in yields would cut the price of a bond with only two years left to about $981 — a much smaller fall, because there are fewer years of below-market coupons left to compensate for.

The approximation and the exact answer

Yield to maturity has no simple formula; it is the interest rate that makes the present value of all the coupons and the final repayment equal today’s price, and it is found by trial and error. A widely used shortcut is: YTM ≈ (annual coupon + (face value − price) ÷ years) ÷ ((face value + price) ÷ 2). For the discount bond above, that gives about 5.64%, very close to the exact 5.66%.

The shortcut is good enough for quick comparisons, especially for bonds priced near par. For deep discounts, long maturities, or anything you plan to act on, use the exact figure.

What yield to maturity assumes

YTM is the return you earn only if three things happen: you hold the bond to maturity, the issuer pays every coupon and the face value in full, and you can reinvest each coupon at the same yield. If you sell early, the price at that moment decides your return. If the issuer defaults, you may receive much less. And if rates fall, reinvested coupons will earn less than the original yield.

A very high yield to maturity is often a sign that the market doubts the issuer will pay in full. As with dividend yields, an unusually generous number deserves a question before it deserves your money.

Don’t forget inflation

Bond yields are nominal. A 5.66% yield to maturity with 3% inflation is a real yield of only about 2.6% a year in purchasing power — see nominal vs. real return for how that conversion works.

Work out current yield, approximate and exact yield to maturity, and a real yield after inflation with the bond yield calculator.