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Coupon Rate Vs. YTM: What’s the Difference?

Investors who are risk-averse or wish to diversify their investment portfolios are likely to consider bonds or debt mutual funds as an investment option. While bonds do have their share of risks, they are likelier to be less risky than equities as an asset class. At the same time, bonds and debt mutual funds have the potential to offer rates of return that may be relatively better than traditional financial instruments. But how are these rates of return determined? This article tries to explain the core differences between two return metrics – coupon rate and yield to maturity (YTM).

What is the Coupon Rate?

When you invest in bonds, you are entitled to interest payments as the bond owner. The coupon rate is nothing but the amount of interest that a bondholder will receive annually and is expressed as a percentage. For instance, if you purchase a bond with a face value of Rs 1,000, which has an annual coupon rate of 10%, then the annual interest you will receive is Rs 100. Depending on the type of bond, coupon rates can also be paid semi-annually or annually. Irrespective of the market value of the bond, coupon rates remain fixed throughout the tenure of the bond, although some bonds can offer variable rates.

What is Yield to Maturity?

YTM is nothing but the percentage rate of return on the bond at a particular point in time, assuming that the bond holder holds the bond till maturity. It is important to note that bonds can be traded on the exchanges like equity shares, and bond prices are inversely proportional to interest rates. Thus, the yield to maturity will fluctuate depending on the changes in the market price of the bonds and the time left until maturity. If the bond’s market value is higher than the face value, then the bond is trading at a premium, and the yield to maturity on the bond will accordingly be lower than the coupon rate and vice versa.

Coupon Rate Vs. Yield to Maturity: Salient Points of Difference

The following table seeks to compare yield to maturity vs coupon rate, highlighting the essential differences between the two metrics:
​Coupon RateYield to Maturity
DefinitionIt is the annual interest payment that the bondholder will receive.It is the percentage rate of return on the bond, assuming the bondholder holds it till maturity.
Method of CalculationThe coupon Rate is calculated using the coupon payment as the numerator and the face value of the bond as the denominator. In the Yield to Maturity calculation, it is the rate at which all the future cash flows of the bond are discounted to arrive at the current market price.
Fixed or Fluctuating?Coupon rates are typically fixed rates of return throughout the bond’s duration unless the bond specifically offers floating interest rates. The yield to Maturity of a bond can rise or fall depending on prevailing interest rates in the market.
Type of investorA bond investor will most likely look at coupon rates while investing. A bond trader, who buys and sells bonds in the secondary market, is more likely to consider the yield to maturity.

To conclude…

Yield to maturity is generally considered a more comprehensive metric because it considers the coupon payments, the face value as well as the market value of the bond. However, if you are an investor who has purchased a bond with the intention of holding it to maturity, then the coupon rate is the metric that might work better for you.
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Disclaimer:
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The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their associates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document. Language Disclaimer:
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