If you are among those investors who prefer to minimise risk, then you have probably already considered investing in debt mutual funds or bonds.
Although bonds still share some risks, they are comparatively a lot safer when compared to equity-linked securities. Besides, their potential returns can beat other forms of traditional financial instruments like term or fixed deposits.
Before you start prioritising bond investment, it is crucial to get a thorough idea of bond coupon rates, yield to maturity and other related factors that help assess their rates of return precisely. Having said that, in this blog, we will walk you through a comprehensive guide on coupon rate vs yield to maturity (YTM).
What Is a Coupon Rate?
As you invest in corporate or government bonds, you become eligible to receive regular interest payouts as bond owners. The coupon rate is simply the annualised returns that you are entitled to receive from the bond issuer. Before buying a bond, you must check it out.
Suppose, you buy a bond unit that has a face value of ₹1,000 and has promised to provide each bond owner with a coupon rate of 10%. In that case, you will earn ₹100 as interest in 1 year.
Based on the type of bond you invest in, the payout frequency of coupon payments varies. For instance, you can purchase bonds that guarantee monthly payouts, thereby generating a regular cash flow. Additionally, when you invest in fixed-rate bonds, your coupon payments are a fixed amount throughout the tenure, which in turn, contributes to the predictability of your annual income.
What Is Yield to Maturity?
Yield to Maturity is another key metric that denotes the percentage bond return rate at a particular period of time, considering that you will hold your bond units until maturity.
As bonds can be readily traded on stock exchange platforms, their prices are inversely proportional to the coupon rates offered. For the same reason, the YTM of a bond exhibits a volatile nature till the maturity date arrives.
If a bond’s market price exceeds its face value, it is trading at a premium, and its yield to maturity will be lower than its coupon rate. Alternatively, if the market price is below the face value, then that bond is at a discount, and the yield to maturity will be higher than the coupon rate.
Coupon Rate vs Yield to Maturity: Key Differences
To grasp the key differences between coupon rate and yield to maturity, go through the table below:
| Parameter | Coupon Rate | Yield to Maturity |
| Definition | Coupon rate is the interest that you receive throughout the tenure of a bond investment. | YTM is the percentage rate of return which is calculated by assuming that you will hold the bond until maturity. |
| Calculation Method | To calculate the coupon rate, you must divide the coupon payment by the face value of the bond. Further, to convert it into a percentage, multiply the result by 100. | While calculating the YTM, you have to assume it as the rate at which all upcoming cash flows will be discounted to achieve the current market price of the bond. |
| Nature of Fluctuation | The coupon rate of most bonds except floating-interest-rate bonds is fixed. | YTM, on the other hand, can rise or dip based on the interest rates prevalent in the secondary market. |
| Investor Type | Before investing, a person is likely to verify the prevailing coupon rates of a bond. | Traders, who keep on selling and buying bonds in the secondary market, are more likely to verify the yield to maturity before putting their money. |
Final Word
To determine which metric to focus on when deciding whether to hold a bond until maturity, it is crucial to understand the difference between coupon rate vs yield to maturity. Yield to maturity is often regarded as a more comprehensive metric since it takes into account the coupon payments, the bond’s face value and its current market price. However, if you are an investor who has just purchased a bond, the coupon rate is one of the first key factors you should be familiar with.
Frequently Asked Questions
If you purchase units of a bond at a discounted price, then its yield to maturity will be greater compared to its coupon rate. Conversely, if you pay a premium price then the YTM will be lower than the bond’s interest rate or coupon rate.
When a bond exhibits a high yield to maturity percentage, it indicates that they are less susceptible to interest rate fluctuations. However, there can still be other forms of risks associated like the bond being called well ahead of maturity or the risk of default coupon payments, etc.
Some investors also refer to coupon rates as nominal yield or coupon payment. It is the fraction or percentage that denotes how much one can earn yearly as interest upon investing in fixed-income bonds. Additionally, the coupon payments received from bond investments are subject to taxation.
