Yield vs Coupon
Yield and Coupon are terms that are associated with the purchase of bonds. These terms are quite different to each other, even though many have confused them to have a similar meaning. A yield on a bond is the percentage return that is earned on the bond in terms of the price paid and the interest earned. The interest rate that the bondholder receives is called the coupon rate. Both these items of information are essential to determine whether an investment made in bonds is profitable or not. The following article offers comprehensive explanations on each term and explains the similarities and differences between the two.
Yield
The yield of a bond is the amount or the percentage return that a bondholder can expect to obtain from investing in bonds. The yield of a bond will be calculated by taking into consideration the current price of the bond, rather than the price that remained at the time the purchase was made. In order to calculate the bond’s yield, it is important to find out the bond’s coupon rate. A simple formula for calculating the bond’s yield is
Yield = Coupon/Price
This means that the price of the bond will change according to the bond’s price. In the event that the bond is sold at a lower price, the investor can obtain a higher yield. If the bond is sold at a higher price, the investor will have a lower yield on their bond.
Coupon
A bond is a form of debt to a firm. When an individual purchases a company’s bond, the investor essentially loans the funds to the firm with the agreement that interest will be paid on the funds lent and that the total amount borrowed will be returned at maturity. A bond’s coupon is the interest that is paid out on a yearly basis to the bond holder. There are also some bonds known as zero coupon bonds. For these bonds, there are no interest rates that apply, and these bonds are issued for less than their face value. The profit that is obtained by the investor is in the difference between the price that was paid for the bond at the time of purchase and the amount that was returned at maturity (which will be higher than the purchase price).
What is the difference between Yield and Coupon?
A coupon rate is the interest rate that a bondholder receives for lending money to a corporation. The yield on the bond is the overall percentage return that is calculated from the coupon rate and the price of the bond at the time. The difference between the two can be clearly demonstrated with an example. A company issues a bond at $1000 par value that has a coupon interest rate of 10%. So to calculate the yield = coupon/price would be (coupon =10% of 1000 = $100), $100/$1000. This bond will carry a yield of 10%. However in a few years’ time the bond price will fall to $800. The new yield for the same bond would be ($100/$800) 12.5%.
Summary:
Yield vs Coupon
• Yield and Coupon are terms that are associated with the purchase of bonds. These terms are quite different to each other, even though many have confused them to have a similar meaning.
• The yield of a bond is the amount or the percentage return that a bondholder can expect to obtain from investing in bonds.
• A bond’s coupon is the interest that is paid out on a yearly basis to the bond holder.
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