What is Bond yield?

A bond is a loan to a government or a company. The borrower makes fixed interest payments, called coupons, and repays the original amount, called the face value, on a set end date known as maturity. The bond yield expresses the return those payments represent, compared with the price paid for the bond, as a percentage per year. Bonds are bought and sold after they are issued, so their prices move. The coupon stays fixed, which means the yield changes whenever the price does.

Say a bond has a face value of $1,000, pays a coupon of $40 a year and matures in five years. Bought at $1,000, it yields 4%: $40 divided by $1,000. Now suppose interest rates across the economy rise and the bond's market price falls to $900. A new buyer still receives $40 a year, so the current yield is $40 divided by $900, about 4.4%. The buyer also gets $1,000 back at maturity, a $100 gain over the price paid. Yield to maturity, which counts every coupon plus that gain spread over the remaining five years, works out at about 6.4% a year in this hypothetical case.

The most common misunderstanding is treating a high yield as free extra return. A higher yield usually compensates for something: a greater chance that the borrower fails to pay, known as credit risk, or a longer time to maturity, which makes the price more sensitive to interest-rate changes. Yield to maturity also rests on assumptions: the bond is held to the end, the borrower pays in full and coupons are reinvested at the same rate. Finally, yields are nominal, meaning before inflation. In 2022, US inflation reached about 9% and long-term Treasuries lost about 30%, a reminder that rising rates push existing bond prices down and that inflation erodes fixed payments.

For a private investor building a long-term portfolio, bond yield is the clearest single guide to what high-quality bonds offer before inflation. The starting yield on a government bond held to maturity is close to the nominal return it delivers, which makes it useful when setting realistic expectations for a mix of stocks and bonds. Comparing yields with inflation, with cash rates and with each other helps investors judge how much return they are being paid for taking on time and credit risk.

By Dr. Harry Hamann

Why do bond prices fall when yields rise?
A bond's coupon is fixed. When new bonds offer higher rates, buyers will only purchase an older, lower-paying bond at a lower price. That lower price raises its yield until it roughly matches what new bonds pay.

What is the difference between coupon rate and yield?
The coupon rate is the fixed interest as a percentage of face value and never changes. The yield compares the payments with the bond's current market price, so it moves as the price moves.

What is yield to maturity?
Yield to maturity is the annual return from buying a bond today and holding it until it is repaid, counting all coupons plus any gain or loss between the purchase price and face value.