The rates of returns that any bond or debt mutual fund can offer are determined using two metrics: coupon rate and yield to maturity (YTM).
An investor in bonds is entitled to receive regular interest payments. The coupon rate is the amount of interest that an investor will receive annually. It is expressed as a percentage. The coupon rate is calculated using the coupon payment as the numerator and the face value of the bond or debt mutual fund as the denominator.
As per the type of bond, coupon rates can also be paid semi-annually or annually. Coupon rates tend to remain fixed throughout the tenure of the bond. Some bonds can offer variable rates, though. This is, however, irrespective of the market value of the bond.
On the other hand, YTM is the expected annual rate of return earned on a bond under the assumption that the debt security is held until maturity. Bonds can be traded on the exchanges similar to equity shares. Bond prices are inversely proportional to interest rates.
When considering the YTM calculation, it is the rate at which all the future cash flows of the bond are discounted to arrive at the current market price.
The YTM will fluctuate depending on the changes in the market price of the bonds and the time remaining until maturity. If the bond’s market value is higher than the face value, then the bond is trading at a premium, and the YTM on the bond will suitably be lower than the coupon rate and vice-versa.
Generally, YTM is regarded as a more comprehensive metric as it considers the coupon payments, the face value, and the market value of the bond. However, an investor who has purchased a bond while intending to hold it until maturity then considers the coupon rate is the metric that would work better.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.