Futures and Options

Difference Between Coupon Rate and Yield of Maturity

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Difference Between Coupon Rate and Yield of Maturity

A coupon rate is a rate at which the interest payment of a bond is made to the investor. It represents the yearly interest rate paid by the bond with respect to its face value denoted as a percentage.
The coupon rate is like fixed income security for governments in which the issuer of the bond receives the annual interest payments.
Let’s understand with the help of an example given below:
Assume that a particular company issues a bond with a face value of Rs. 20,000. The rate of interest on this bond is set at 20% per annum. Here, the 10% per annum is called the coupon rate. So, when investing Rs. 20,000 in the bond, they will receive Rs. 4,000 per annum as interest payments.

The yield to maturity is the return rate that investors hold while holding the bond until maturity. The yield to maturity becomes relevant only when an investor purchases the bond from the secondary market.
The formula for calculating the yield of maturity of a bond is:
YTM = {(Annual Interest Payment) + [(Face Value – Current Trading Price) ÷ Remaining Years To Maturity]} ÷ [(Face Value + Current Price) ÷ 2]
Let’s understand with the help of an example given below:
An investor has a bond with a face value of RS 10,000 and a coupon rate of 10%. Let’s assume that the bond is trading on the market currently at RS 9,200.
Say five years are remaining for the bond’s maturity to get over, with interest being paid out two times in a single year.
The yield of maturity of such a bond is given below:
{(1,000) + [(10,000 – 9,200) ÷ 5]} ÷ [(10,000 + 9,200) ÷ 2] = 0.1208 or 12.08%

The major difference between coupon rate and yield of maturity is that coupon rate has fixed bond tenure throughout the year. However, in the case of the yield of maturity, it changes depending on several factors like remaining years till maturity and the current price at which the bond is being traded.
Here’s another example that clearly tells the difference between coupon rate and yield of maturity. Assume that there’s a bond with a face value of RS 20,000 with a 20% coupon rate.

Let’s look at how coupon rate and yield of maturity reacts in different situations:

Purchase of Bond 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 above example shows the inverse relationship between yield to maturity and the price of the bond.
Here’s look at the other major differences between coupon rate and yield of maturity:

SR No Coupon Rate Yield of Maturity
  • 1
  • The amount paid by the issuer to the bondholder until it’s maturity is called coupon rate.
  • The yield of maturity means the total return earned by the investor until it’s maturity.
  • 2
  • The rate of interest is paid annually at a coupon rate.
  • The current Yield defines the rate of return it generates annually.
  • 3
  • Interest rate fluctuates in the coupon rate.
  • The current yield compares the coupon rate to the market price of the bond.
  • 4
  • The coupon amount remains the same till its maturity.
  • The market price keeps on changing so it’s better to purchase a bond at a discount which represents a larger share of the purchase price.
  • 5
  • Coupon gives all the information like what bond is paid and when it was issued.
  • The yield of maturity defines how much you will be paid in the future.
  • 6
  • Coupon Rate or Nominal Yield = Annual Payments / Face Value of the Bond.
  • Yield to Maturity = (C + (F-P)/n)*2/(F+P)
  • 7
  • No matter at whichever price the bond is traded, the coupons are fixed.
  • The prices and yield are inversely related to each other.
  • 8
  • The coupon rate is equal to the yield of maturity.
  • The yield of maturity is higher than the coupon rate because an investor purchases the bond at a discount.
  • What is the Coupon Rate?

    • A coupon rate is a rate at which the interest payment of a bond is made to the investor. It represents the yearly interest rate paid by the bond with respect to its face value denoted as a percentage.

  • What is Yield to Maturity?

    • The yield to maturity is the return rate that investors hold while holding the bond until maturity. The yield to maturity becomes relevant only when an investor purchases the bond from the secondary market.

  • What is the major difference between a coupon rate and yield of maturity?

    • The major difference between coupon rate and yield of maturity is that coupon rate has fixed bond tenure throughout the year. However, in the case of the yield of maturity, it changes depending on several factors like remaining years till maturity and the current price at which the bond is being traded.

Conclusion

The purpose of this distinction between coupon rate and yield of maturity is to clear the terms for those who have some or limited experience in the financial industry.
These two major terms, coupon rate and yield of maturity, are commonly known while managing or operating bonds.
Moreover, combining these will help you reap returns and translate into the concept higher coupon rate, which means higher yield.
Apart from the usage in bonds, both terms are quite different from each other.