I’ve been reading through some bonds and I keep seeing coupon rate and yield but I’m still not clear on the difference. Can someone explain?
Coupon rate is just the percentage of face value you get paid as interest, right? Yield is more complicated.
Yeah, I thought yield was the return, but why is it different from coupon rate?
Coupon rate is fixed, based on the face value of the bond. Yield changes based on the price you paid for the bond. If you pay more than face value, your yield will be lower than the coupon rate.
Wait, so if I pay extra for the bond, I get less return? Doesn’t sound great.
Yeah, yield reflects the return relative to the price you paid. So, if you buy at a premium, your effective return will be lower than the coupon.
Exactly, the yield adjusts for the price you enter at. If you buy the bond at face value, your yield and coupon rate are the same. But if you buy above or below, the yield changes accordingly.
Okay, so yield is basically how much I’m actually getting based on what I paid for the bond?
That’s pretty much it. So, if you’re paying more, you get less in return.
It’s why people focus on yield more than coupon rate. Yield gives a more accurate picture of your actual return, especially if you’re buying bonds on the secondary market.
Got it. So, it’s more about the price I’m paying than just the coupon rate on paper.
Exactly, it’s all about the price!