How are bond yields different from coupon rate? - The Financial Express
A bond's maturity date is simply the date on which the bondholder receives repayment for his investment. At maturity, the issuing entity must pay the bondholder the par value of the bond, regardless of its current market value. The market value of bonds has a negative correlation with prevailing interest rates.
As interest rates go up, the price of pre-existing bonds goes down. As rates decline, current bonds with higher rates become more valuable.
See Why do interest rates have an inverse relationship with bond prices? To entice investors to purchase the bond despite its lower coupon payments, the company has to sell the bond at less than its par value, which is called a discount.
- What is the difference between yield to maturity and the coupon rate?;
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- When is a bond's coupon rate and yield to maturity the same?.
Since the market price of bonds is so changeable, it is possible to make a profit in addition to that generated by coupon payments by purchasing bonds at a discount. The yield to maturity of a bond is the rate of return generated by a bond after accounting for its market price, expressed as a percentage of its par value.
Considered a more accurate estimate of a bond's profitability than other yield calculations, the yield to maturity of a bond incorporates the gain or loss created by the difference between the bond's purchase price and its par value. The coupon rate is often different from the yield.
A bond's yield is more accurately thought of as the effective rate of return based on the actual market value of the bond. At face value, the coupon rate and yield equal each other.
What is the difference between yield to maturity and the coupon rate?
If you sell your IBM Corp. Because coupon payments are not the only source of bond profits, the yield to maturity calculation incorporates the potential gains or losses generated by variations in market price. If an investor purchases a bond for its par value, the yield to maturity is equal to the coupon rate. If the investor purchases the bond at a discount, its yield to maturity is always higher than its coupon rate. Yield to maturity approximates the average return of the bond over its remaining term. A single discount rate is applied to all future interest payments to create a present value roughly equivalent to the price of the bond.
The entire calculation takes into account the coupon rate; current price of the bond; difference between price and face value; and time until maturity. Since it is possible to generate profit or loss by purchasing bonds below or above par, this yield calculation takes into account the effect of the purchase price on the total rate of return. If a bond's purchase price is equal to its par value, then the coupon rate, current yield, and yield to maturity are the same.
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Yield to maturity
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- The Difference Between a Bond's Yield Rate and Its Coupon Rate;
- Yield to maturity - Wikipedia;
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