Three yields, one bond

One bond, three numbers, all called a yield. They differ by what each one counts, and the differences are largest exactly when a bond is furthest from its face value, which is when someone is most likely to be quoting the flattering one.

Coupon rate

Fifty dollars a year on 1,000 of face value is a 5 percent coupon. It is fixed by the document at issue and it never changes, whatever the price does. It tells you the cash, and it tells you nothing about the return on what you paid.

Current yield

This corrects for the price. If you paid 957.88 for 50 a year of income, your income yield is 5.22 percent, not 5 percent. It is a fair description of the cash return in any single year.

What it leaves out is the principal. You paid 957.88 for something that repays 1,000 at maturity, and that 42.12 gain is real and is not in the number.

Yield to maturity

This counts both: the coupons and the pull back to face value over the remaining life. For this bond it is 6 percent, a full point above the current yield.

The relationship is fixed and worth memorising, because it is a quick check on any quote you are handed.

Which one gets quoted

Current yield is the number that flatters a premium bond, because it ignores the capital loss the holder takes as the price falls towards face. A bond bought at 1,100 with a 6 percent coupon shows a current yield of 5.45 percent and a yield to maturity below it, and the difference is a loss already scheduled.

The habit worth keeping is to ask which of the three a quoted yield is, and to treat a bond priced far from face as the case where the question matters most.

And what none of them include

A yield of any kind assumes the issuer pays. None of the three contains a probability of default, a recovery rate or a downgrade. A bond yielding 12 percent is not offering 12 percent; it is offering 12 percent if paid, and the market has priced that "if" into the price the yield was computed from.

Check yourself