Difference Between Coupon Rate and Yield to Maturity (With Table)

As our elders say, “Savings is the key to live life secure,” which means everyone should save money and resources for future generations and also secure the bank balance for an upcoming emergency. Investments are one of the methods to safeguard and protect hard-earned money to be further used in a crisis. Therefore, while making investments, everyone came across many terminologies that they do not know about and cannot distinguish between them; thus, Coupon Rate and Yield to Maturity (YTM) are two of them.

Coupon Rate vs Yield to Maturity

The difference between Coupon Rate and Yield to Maturity (YTM) is that Coupon Rate is the fixed sum of money that a person has to pay at face value. In contrast, Yield to Maturity (YTM) is the amount a person will retrieve after the maturation of their bonds.

The Coupon Rate is said to be the same throughout the bond tenure year. Also, it is known as “Bond Yield” sometimes to make the terms a little bit complicated. The Coupon Rate represents the annual interest a person is going to receive. It is calculated manually and is based on the face value and not on the market price.

Yield to Maturity (YTM) can be defined as those bonds an individual receives after the bond maturation date. The value of mature bonds is said to be higher. It can be calculated with the help of financial calculators, which are now available on the internet. Also known as “Book Yield” or Redemption Yield.

Comparison Table Between Coupon Rate and Yield to Maturity (YTM)

Parameters of ComparisonCoupon RateYield to Maturity
Definition It is the amount to be paid by the bond issuer on the face value.It is the amount of money the bond issuer gets after his/her maturation of the bond.
FormulaAnnual Payment/Face Value × 100{CP+(FV-PP/n)}/{FV+PP/2}
RateIt remains the same for the entire year.It changes depending on the current market price and the time remaining for the maturation of the bond.
What it represents?It represents the annual interest payment rates that the bond issuer will receive.It represents the average return received by the issuer.
Also Known AsBond YieldRedemption Yield or Book Yield

What is Coupon Rate?

Coupon Rate is the fixed rate that will be paid by the person on the face value. It is somewhat like fixed-income security for government or corporate bonds and is also known as “Yield from the Bond.” This term is sometimes used to make the topic more complicated. The coupon rate represents the annual interest payments that will be received by the issuer of the bond. 

The coupon rate can be measure with the simple mathematical formula by dividing the annual payment by the face value of the bond multiplied by 100. This formula can be deduced as follows:

Coupon Rate = Annual Payment / Face Value × 100 

Face value is used to define the maturity value of bonds and the dollar value of the coupon. The market value of the bond can be fluctuating, i.e., it can be higher or lower. It also depends on the interest rate and the current credit status of the bond.  

What is Yield to Maturity?

Yield to Maturity (YTM) is defined as the individual who will receive the total amount of money after the maturation of their bonds. Yield to Maturity (YTM) bonds are considered to be long-term. Also known as “Redemption Yield” and “Book Yield.” 

The most significant assumption related to Yield to Maturity (YTM) is that it was invested for half a year and should reinvest within the same if you save your money. The term can be compared to the current market yield as it helps to measure the cash inflows of a particular bond at the current market value and tells the individual how much they can invest and make a profit out of it.  

Yield to Maturity (YTM) can be calculated as follows:

Yield to Maturity (YTM) = {CP+(FV-PP/n)}/{FV+PP/2}

The above abbreviations are used for the following terms –

CP = Coupon Payment

FV = Face Value

PP = Purchase Price 

n = Year left till Maturation Period

Main Differences Between Coupon Rate and Yield to Maturity

  1. Coupon rate can be stated as the sum of money which a bond issuer has to pay relative to its bond value, while Yield to Maturity (YTM) can be defined as the total money which is to be accepted by an individual after the maturation.
  2. The coupon rate is also known as “Yield from the Bond.” This term is used to complicate things at some point while Yield to Maturity (YTM) is also known as “Redemption Yield” and “Book Yield.” 
  3. The coupon rate remains the same throughout the bond tenure year, while Yield to Maturity (YTM) changes with the period left for the bond maturation and also on the current market value of the bond. 
  4. The coupon rate represents the interest payment rates that are to be received annually by the bond receiver. In contrast, Yield to Maturity (YTM) represents the average return received by the bond issuer.
  5. The coupon rate tells you about when is the bond paid when it was issued, while Yield to Maturity (YTM) tells you about how much will be delivered in the future.

Conclusion

While making your investments, always try to know about the investment, return, interest value in depth. Any discrepancy will be harmful to you in the future. That is why it is also said that investing in mutual funds, stocks, premium bonds are risky and should be carefully studied.

The above terms are associated with the various investments. By calculating the coupon rate, we can find the best stocks or bonds for making investments in the future as people mainly invest in stocks/bonds with higher coupon interest rates. Investors who buy bonds from the secondary market (Yield to Maturity) get a higher return from the bonds’ interest payments.

References

  1. https://www.jstor.org/stable/2326906?seq=1#metadata_info_tab_contents
  2. https://ideas.repec.org/p/mnb/wpaper/1998-2.html