The terms used to describe a bond’s performance can be confusing. Yield to maturity, current yield, and coupon rate are all used to assess bonds and each is expressed as a percentage.
In this article, we’ll explain five of the key terms used to describe bonds:
- Coupon rate
- Face value
- Current price
- Current yield
- Yield to maturity
We’ll not only help you understand what these terms mean, but also learn which measure you should focus on above all others.
Key measures for a corporate bond
|COUPON RATE||FACE VALUE||CURRENT PRICE||CURRENT YIELD||YIELD TO MATURITY|
The amount returned to investors at maturity
The amount investors pay for this XTB on ASX
(coupon/price) x 100
The total return you should receive if you hold to maturity. It is the best measure for investors.
Source: XTB 05 AUG 2020
Face value is the value that was assigned to the bond at the time it was issued. It is also the amount that will be returned to the holder when the bond matures. For all XTBs, this is $100.
Coupon rate is the rate of interest a bond will pay annually. It is expressed as a percentage of the face value, so a 4% coupon means investors receive $4 per annum for each $100 of face value they hold of that bond.
The coupon rate remains constant throughout the life of the bond at the rate set by the bond issuer at the time of issue.
A bond’s current price is the amount it would cost to buy a particular bond today. Two factors that affect a bond’s current price are:
- interest rates and
- the time remaining until the bond matures.
Find out more about the relationship between price and yield here.
Current yield, also known as running yield, is the bond coupon rate expressed as a percentage of the current price.
Example of current yield:
- A bond with a coupon rate of 4% pays $4.00 per $100 of bond held p.a. until it matures in 2027.
- If the current price that the bond was trading at was $112.22, its current yield would be (4.0%/112.22)*100% = 3.56%.
- With a 4% coupon rate, investors would receive $4.00 for every $100 of bond face value they own. They would receive this for the whole time they hold the bond, until it matures. From a yearly cash flow perspective they receive a 3.56% return on the $112.22 they paid for the bond.
One thing to note is that current yield does not factor in the face value ($100) the bond holder will receive at maturity.
Yield to Maturity
When you hear people talking about the ‘yield’ of a bond, they’re usually talking about the Yield to Maturity, or YTM. The YTM of a bond is the ‘total return’ an investor should receive if they buy a bond today and hold it to maturity. This measure includes receiving the face value (of $100) at maturity.
This metric assumes:
- The investor can reinvest all coupons at the same yield; and
- The bond issuer remains viable and does not default.
Yield to Maturity is a measure of returns that should be achieved on the assumptions above, given the known outcomes associated with bonds.
Example of Yield to Maturity
In the example above, an investor bought a bond with a coupon of 4.00% and a face value of $100 for $112.22. The bond will mature in 2027.
However, that does not mean that the investor will receive a total return of 4.00%.
- At maturity in 2027, the holder will receive the face value of $100 back and not the $112.22 they paid.
- The $12.22 loss is amortised over the life of the investment and is included in the yield to maturity calculation.
- YTM therefore gives a much more accurate picture of returns.
Comparing bond measures
Coupon rate vs. current yield vs. yield to maturity
A bond issued today with a coupon rate of 4% which started trading at $100, would have a current yield of 4%. Because it is still trading at $100 its Yield to Maturity (YTM) would also be 4%. But, this is one of the only times these three bond parameters would ever have the same value.
As soon as the bond starts trading at a value other than $100, the YTM and the current yield will be different to the coupon rate. The coupon rate remains constant throughout the life of the bond, because it is simply the rate set by the bond issuer when it was issued.
Tip: You can find all three of these measures for the range of XTBs via our Available XTBs table. Sort the columns to order any of the data from highest to lowest.
Yield to maturity vs. current yield
A bond’s current yield does not factor in the face value that the holder will receive at maturity. Instead, it simply tells you what the cash flow from coupons will be each year, as a percentage of the bond purchase price.
Yield to maturity does take into account any capital gain or loss, that occurs as a result of receiving the face value, not the purchase price at maturity. Whether investors make a capital gain or loss at maturity is dependent on whether a bond is acquired at a discount (less than) or premium (more than) to face value.
YTM is a much more useful measure of bond returns than current yield.
Bond measures example: Qantas 7.75% 2022
This example is the Qantas 7.75% 2022 bond which the XTB on ASX covers. It has a very high coupon rate of 7.75% because it was issued in 2014 when the cash rate was much higher than today. At that time, Qantas needed to pay higher coupons to get fund managers to invest for 10 years.
On 05 August 2020, its YTM was 2.45%. The YTM considers the future capital loss of investors receiving $100 face value back on maturity. This rate reflects the markets required yield on a bond issued by an A-rated issuer like Qantas, with the cash rate at 0.25% and 12-month TDs generally offering under 1%.
The current yield simply tells you what the cash flow from coupons each year will be, as a percentage of the bond purchase price. Otherwise, it’s best to ignore current yield as a measure of returns and focus on YTM.
Using Yield to Maturity to make an informed bond investment decision
Because bonds mature, as an investor you know you will getting the $100 face value back¹, plus the known income from coupons along the way.
This predictability of returns is one of the fundamental reasons people have been investing in bonds for centuries. You can plan your outgoings against known income and capital returns. Yield to Maturity is a very powerful measure of bond returns.
If you are happy with the rate based on the YTM on the day you invest, there are no surprises with corporate bonds. That rate is determined when you invest. This allows you to plan your expenses with the knowledge of the exact dates your coupons will be received.