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Difference Between Coupon and Yield
Coupon refers to the amount which is paid as the return on the investment to the holder of the bond by bond issuer which remains unaffected by the fluctuations in purchase price whereas, yield refers to the interest rate on bond that is calculated on basis of the coupon payment of the bond as well as it current market price assuming bond is held till maturity and thus changes with the change in the bond’s market price.
What is Coupon Rate?
Whenever a bondholder decides to put his money on a bond, he needs to look at certain parts that make up a bond. A bond has a face value, which is the amount the bondholder will receive at the time of maturity from the issuer of the bond. The coupon rate on the bond is calculated on the basis of the face value of the bond.
For example, suppose the face value of an XYZ bond is $1000, and the coupon payment for the bond is $20 semi-annually, then on an annual basis, the total coupon that will be received by the investor will be $40. The way the coupon rate is calculated is by dividing the annual coupon payment by the face value of the bond. In this case, the coupon rate for the bond will be $40/$1000, which is a 4% annual rate.
It can be paid quarterly, semi-annually, or yearly depending on the bond. Irrespective of the change in the price of a bond, the coupon rate will remain fixed for the life of the bond.
What is Yield to Maturity?
Yield to maturity is the effective rate of return of a bond at a particular point in time. On the basis of the coupon from the earlier example, suppose the annual coupon of the bond is $40. And the price of the bond is $1150, then the yield on the bond will be 3.5%.
Coupon vs. Yield Infographic
Let's see the top differences between coupon vs. yield.
Key Differences
- For the calculation of the coupon rate, the denominator is the face value of the bond, and for the calculation of the yield of a bond, the denominator is the market price of the bond.
- The coupon rate is fixed for the entire duration of the bond as both the numerator and the denominator for the calculation of the coupon rate do not change. The yield of a bond changes with the change in the price of the bond.
- Change in the interest rate in the economy by the central bank has no effect on the coupon rate of a bond. The price of a bond is inversely proportional to the interest rates. The yield of a bond changes with the change in the interest rate in the economy.
Coupon vs. Yield Comparative Table
| Basis | Coupon Rate | Yield |
|---|---|---|
| 1. Definition | The coupon is similar to the interest rate, which is paid by the issuer of a bond to the bondholder as a return on his investment. | The yield to maturity of a bond is the interest rate for a bond, which is calculated on the basis of coupon payment and the current market price of a bond. |
| 2. Basis of calculation | The coupon rate is calculated with numerator as the coupon payment and the denominator as the face value of the bond. | The coupon rate is calculated with numerator as the coupon payment and the denominator as the market price of the bond. |
| 3. Effecting delta | The coupon rate remains fixed for the entire duration of a bond as the coupon payment is fixed, and also the face value is fixed. | Yield changes with the change in the market price of a bond. |
| 4. Effect of interest rate | Change in the interest rate in the economy by the central bank has no effect on the coupon rate of a bond. | The price of a bond is inversely proportional to the interest rates. With the increase of interest rate, the price of a bond will decrease, as the investor then will look for a higher yield from a bond. And with the decrease of interest rate, the price of a bond will increase as then the investor will happy with the lower interest rate. |
| 5. Example | Suppose the face value of an XYZ bond is $1000, and the coupon payment is $40 annually. The way the coupon rate is calculated is by dividing the annual coupon payment by the face value of the bond. In this case, the coupon rate for the bond will be $40/$1000, which is a 4% annual rate. | Suppose the annual coupon of a bond is $40. And the price of the bond is $1150, then the yield on the bond will be 3.5%. |
Final Thoughts
Coupon rates and yield are very important components of a bond for an investor in a bond. The coupon rate is paid either quarterly, semi-annually, or yearly depending on the bond. On the basis of the coupon payment and face value of the bond, the coupon rate is calculated.
The yield of the bond, on the other hand, is the interest rate on the basis of the current market price of the bond and is thus also known as the effective rate of return for a bond. The yield of a bond changes with a change in the interest rate in the economy, but the coupon rate does not have the effect of the interest rate.
