Does a bond’s coupon describe your return?

A fixed-rate bond’s coupon percentage does not, by itself, describe the return on the price paid. The coupon uses the bond’s face value as its base. A buyer may pay a different amount, and the principal paid at maturity is another part of the cash result.

FINRA’s bond glossary distinguishes the annual coupon rate from how frequently interest is paid. Keep the rate’s stated period and the payment schedule beside the percentage.

One coupon, one maturity date

Consider an invented fixed-rate bond with a $1,000 face value and a contractually specified annual coupon rate of 6 percent. Exactly one year remains until maturity. One $60 coupon and the $1,000 principal are due together on that date.

The supplied current market price at purchase is $960, which is also the complete price paid. The purchase occurs just after the previous annual coupon payment; no accrued interest is owed to the seller.

There are no fees, taxes or borrowing in this model, and no sale or early redemption. Both promised amounts must actually be paid in full and on time for the cash result below to occur. Nothing arrives earlier to be reinvested.

Three percentages, three questions

Coupon rate: 6 percent

The $60 annual interest is divided by the $1,000 face value. Paying $960 does not turn the contract’s coupon amount into $57.60.

Current yield at purchase: 6.25 percent

Divide the $60 annual coupon by the then-current $960 market price. FINRA’s current-yield example compares annual coupon dollars with current market price. This ratio includes coupon income; the principal repaid at maturity is outside its numerator.

One-year cash return: about 10.42 percent

If the promised payments arrive, the buyer receives $1,060 after paying $960. The $100 difference divided by $960 is about 10.42 percent. It includes both $60 of interest and the $40 difference between the purchase price and principal received.

The 10.42 percent is the cash result for this supplied one-year, single-payment schedule. It is not a reproduced market quote for yield to maturity.

Keep the payment; change only the price

Keep the $1,060 payment one year later, but replace the opening price with $1,080 in a separate comparison. What happens to the coupon, current yield at purchase and complete cash return?

The annual coupon remains $60, or 6 percent of face value. Current yield at the new supplied market price is $60 divided by $1,080: about 5.56 percent. Yet receiving $1,060 after paying $1,080 leaves a $20 loss, about negative 1.85 percent of the opening price. The $60 interest does not offset paying $80 above the principal received.

A positive coupon can therefore accompany a negative complete cash return even when every promised payment arrives.

When reading a bond percentage, identify its base, the cash it includes and the dates. For a separate question about valuing dated cash at the start, see net present value. For Vijay Sheth’s business memoir, read the opening of Infinite Upside: Building Wealth With Room to Live.