Identifier: C2T2L2 | Revision: 2026-10-26

Decision and objectives

A 10% coupon bond trades at 95, while a screen displays a yield above 10%. Explain each number before choosing which fits the investor's question. Coupon describes the promise per nominal principal. Current yield relates annual coupon to today's price. Yield to maturity equates price with a dated cash schedule. Holding return measures what actually happened between purchase and exit.

Objectives: Calculate current yield and holding return; Interpret yield to maturity; Separate income from realized performance.

Prerequisites: C2T2L1.

Mechanics

The bond's fixed coupon does not reset when the market price changes. A buyer below par can earn income and a redemption gain if payment occurs in full. A buyer above par can receive a high coupon but lose the premium as redemption approaches. Early sale replaces redemption with an uncertain market value. A coupon receipt and a return percentage are different ledger entries.

Price and return drivers

Coupon rate = annual coupon / face. Current yield = annual coupon / market price, using consistent nominal units. It ignores redemption gain or loss and timing. Yield to maturity (YTM) is the rate that makes discounted promised payments equal to dirty purchase price under a stated compounding convention. It is a cash-flow internal rate, conditional on promises being met. Achieving terminal wealth compounded at YTM also requires intermediate coupons to be reinvested at that rate.

Holding-period return = (sale or redemption cash + income received − initial outlay − later costs) / initial outlay when there are no other external flows. Coupon reinvestment income belongs in the numerator if earned. Do not add current yield to YTM: they describe overlapping cash flows.

Worked case

Hypothetical annual-pay bond: face 100, annual coupon 10, clean and dirty price both 95 at coupon-date settlement, one year remaining, full payment 110 at year-end. No tax, fees or financing. Coupon rate = 10%; current yield = 10 / 95 = 10.5263%; one-year YTM = 110 / 95 − 1 = 15.7895%. The difference reflects the five-point redemption gain.

Separate holding case: buy a different hypothetical bond at dirty 100 just after a coupon, receive coupon 8 after one year and immediately sell at dirty 96. Gross holding return = (96 + 8 − 100) / 100 = 4%. With purchase cost 0.20 and sale cost 0.20 per 100 face, initial outlay 100.20; net proceeds plus coupon 103.80; net gain 3.60; net return = 3.60 / 100.20 = 3.5928%, excluding tax.

Adverse case

In the holding case, a sale price of 89 instead of 96 gives gross return (89 + 8 − 100) / 100 = −3%. The coupon remained positive while total return was negative. If the investor quotes only the 8% coupon, the missing seven points of additional sale loss disappear from the story. Reinvestment may also be below the quoted YTM even when principal is repaid.

Practical use

Request the dealer's YTM convention, dirty price, settlement date and assumed redemption schedule. Callable debt requires yield-to-call and yield-to-worst analysis, taught next. Compare realized performance with actual dated cash, including accrued paid at entry and received at exit. Custody costs and tax may not appear on the trading confirmation; collect them separately. A screen's gross yield should never be described as a personal after-tax result.

Decision boundaries

Current yield can help describe immediate income relative to purchase price, but it is unsuitable for ranking bonds with different redemption premiums or maturities. YTM helps compare scheduled cash but does not forecast early-exit performance. Use holding return for completed periods and scenario cash for future spending decisions. Decline a product sold as fixed return when the promised calculation assumes an unplanned sale at par.

Practice and references

Exercise: hypothetical one-year face 100, coupon 6, price 102, full payment 106; no costs or tax. Answer: coupon rate 6%; current yield 6 / 102 = 5.8824%; YTM = 106 / 102 − 1 = 3.9216%. The two-point premium reduces the total return below the coupon.

Takeaway: identify the denominator, horizon and cash-flow assumptions behind every yield.

Reference guide: domestic-corporate-bond, current-yield, debt-holding-return, Coupon, Current yield, Yield to maturity.

Next: C2T2L3. Topic test: C2T2.

Primary sources (checked 2026-10-26; changing terms require a publication recheck): SEC Investor Bulletin: What Are Corporate Bonds? — Interest rate risk, credit risk, call risk and seniority.

Shared reference guide