Bond yield shows the actual return you earn based on the price you pay, not just the coupon printed on the bond. This guide explains current yield, YTM, and more, so you can evaluate bonds based on real returns, not just headline numbers.
Mr. Financewala is out for lunch with his close friend, Mr. Budgetbhai, who has just received two job offers. Both offer him a CTC of ₹12 LPA. While the first job offer has a higher base salary with fewer allowances, the second job offer has a lower base but more performance bonuses and perks. Explaining this to Mr. Financewala, Mr. Budgetbhai points out, “Both jobs offer the same CTC, but the first one actually puts more money in my pocket every month”.
And somewhere in the middle of that conversation, something clicks for Mr. Financewala.
He realizes that “Bonds work the same way”.
Two bonds can offer the same coupon rate, similar to how two job offers can show the same CTC. But just as your real income depends on how that CTC translates into in-hand salary, your actual return from a bond depends on the price you pay. That’s what a bond’s yield reflects.
In the last chapter, we discussed various market factors that influences bond prices. However, in chapter 4 of this series, we break down what a bond’s yield is, how it differs from the coupon, and why it is the only number that tells you what you are truly earning from a bond.
What is Bond Yield?
Bond yield tells you the actual return you earn based on the price you pay for a bond, not just the coupon written on it.
As we discussed in the last chapter, a bond’s coupon is fixed. But once the bond starts trading in the market, its price changes. And when the price changes, your return changes too. That adjusted return is called yield.
However, there isn’t just one way to measure yield. Depending on how long you plan to hold the bond and its features, different yield measures are used.
Here are the common yield measures you should know about.
What is Current Yield in Bonds?
Current yield is the simplest form of yield. It tells you the return you earn over the next year based on the bond’s current market price.
Formula:
Current Yield = (Annual Coupon ÷ Current Market Price) × 100
Example:
If a bond pays ₹70 annually and is trading at ₹950:
Current Yield = 70 ÷ 950 = 7.37%
What is Yield to Maturity (YTM)?
If current yield captures a moment in time, Yield to Maturity (YTM) reflects the entire journey of the bond. It tells you what you will actually earn over the entire life of the bond, right up to maturity.
YTM accounts for everything:
- Every coupon payment you will receive over the bond’s tenure
- The gain you make if you bought the bond at a discount to its face value
- The loss you absorb if you bought it at a premium
- The time value of money, because ₹1,000 received three years from now is not worth the same as ₹1,000 in your hands today
Formula:
YTM ≈ [C + (F − P) ÷ n] ÷ [(F + P) ÷ 2]
Where:
- C = Annual coupon payment (in ₹)
- F = Face value of the bond
- P = Current market price of the bond
- n = Number of years to maturity
A Practical Example
Say Mr. Financewala is looking at a bond with the following details:
- Face Value (F): ₹1,000
- Annual Coupon (C): ₹90 (i.e., 9% coupon rate)
- Current Market Price (P): ₹950
- Years to Maturity (n): 5 years
Plugging into the formula:
YTM ≈ (90 + (1,000 − 950) ÷ 5) ÷ ((1,000 + 950) ÷ 2)
YTM ≈ (90 + 10) ÷ (975)
YTM ≈ 100 ÷ 975
YTM ≈ 10.26%
Notice what happened here. The bond carries a 9% coupon. But because Mr. Financewala is buying it at ₹950, a discount of ₹50 to its face value, he will receive that ₹50 back at maturity when the issuer repays the full ₹1,000. That capital gain, spread across 5 years, pushes his actual return above the coupon rate to 10.26%.
What is Yield to Call (YTC)?
Yield to Call (YTC) applies to callable bonds, where the issuer may repay the bond before maturity. Unlike YTM, which assumes the bond runs full term, YTC calculates returns assuming early redemption at the call date.
Formula:
YTC ≈ [C + (Call Price − P) ÷ n] ÷ [(Call Price + P) ÷ 2]
Example:
Face Value = ₹1,000, Coupon = ₹90, Price = ₹950
Call Price = ₹1,010, Time = 3 years
YTC ≈ [90 + (1,010 − 950) ÷ 3] ÷ [(1,010 + 950) ÷ 2]
YTC ≈ [90 + 20] ÷ [980]
YTC ≈ 110 ÷ 980
YTC ≈ 11.22%
What is Yield to Worst (YTW)?
Yield to Worst (YTW) is the most conservative return measure. It represents the lowest yield you can earn across all possible scenarios (maturity or early call).
Formula:
YTW = Minimum (YTM, YTC, other yields)
Example:
YTM = 10.26%, YTC = 11.22%
YTW = 10.26%
YTW acts as your return floor, helping you understand the minimum you can expect before investing.
Coupon vs Yield: Understanding the Difference
| Parameter | Coupon Yield | Yield |
| Meaning | Fixed interest paid on face value | Actual return based on price paid |
| Nature | Constant throughout tenure | Changes with market price |
| Basis | Calculated on face value | Calculated on purchase price |
| Investor Relevance | Indicates income promised | Indicates real earning |
| Market Impact | Not affected by price changes | Moves inversely with price |
Conclusion
That evening, Mr. Financewala closed his laptop with a quiet sense of satisfaction. What he’s learning is no longer just surface-level; it’s beginning to make sense in depth. Just as he is about to finalize his shortlist, a notification pops up on his phone: “RBI signals possible rate hike in upcoming policy meeting”.
He pauses. He knows interest rate changes impact bond prices (he learned that in chapter 3). But now the question feels more personal. If rates move, what happens to the yield he just calculated? And what about the issuer? Will everything play out as expected? And just like that, his focus begins to shift to the risks involved in bond investing, which we discuss in the next chapter.
