Bonds are investments that pay a set rate of interest. They’re one of the best risk-averse investment options since they have a lower risk of default and offer a higher return than regular bank FDs.
The Coupon rate refers to the rate at which a bond pays interest payments to the investor. It is expressed as a percentage and indicates the yearly interest rate paid out by the bond in relation to its face value.
The Yield to Maturity (YTM) is the rate of return earned by an investor who keeps a bond until it matures. Only when an investor purchases a bond on the secondary market does the YTM become important.
The following formula is used to determine a bond’s yield to maturity.
| YTM = {(Annual Interest Payment) + [(Face Value – Current Trading Price) ÷ Remaining Years to Maturity]} ÷ [(Face Value + Current Price) ÷ 2] |
Difference between coupon rate and yield to maturity
The main distinction between the coupon rate and the yield to maturity is that the coupon rate remains constant during the bond’s life. The yield to maturity, on the other hand, varies based on a variety of parameters such as the number of years till maturity and the current price at which the bond is traded.
Another illustration of the difference between coupon rate and yield to maturity may be found here. Assume you have a bond with a face value of Rs. 10,000 and a ten percent coupon rate. Let’s take a look at how the coupon rate and yield to maturity respond to various scenarios.
| When The Bond Is Purchased At | Coupon Rate | Yield To Maturity |
| Face Value | 10% | 10% |
| A Price That’s Lower Than the Face Value (I.E. At A Discount) | 10% | Higher Than the Coupon Rate |
| A Price That’s Higher Than the Face Value (I.E. At A Premium) | 10% | Lower Than the Coupon Rate |
The example above not only demonstrates the difference between coupon rate and yield to maturity, but it also demonstrates the inverse relationship between yield to maturity and bond price.
The YTM reflects the average rate of return that an investor is projected to get during the bond’s remaining lifetime, which is another distinction between these two metrics. The coupon rate, on the other hand, reflects an investor’s yearly interest payout.
The coupon rate is what investors should consider when purchasing a bond directly from the firm through a fresh offer to keep invested until the maturity date. In this case, the yield to maturity is entirely meaningless. The yield to maturity, on the other hand, is what bond traders who purchase and sell bonds in the secondary market should consider. This is because any possible profits or losses as a consequence of changes in the bond’s market price are factored into the YTM calculation.