A bond promises $40 in interest each year. One investor pays $1,000 for it and another might pay $800. The promised annual interest is still $40, but the amount of interest relative to what each investor paid is different. That distinction helps explain why a bond described as fixed-rate can have a changing market price.
Calculate the coupon from face value
A corporate bond is a borrowing agreement. With a fixed coupon, the issuer promises interest calculated against the bond’s face value. Imagine a fictional bond with a face value of $1,000 and a 4% annual coupon. Multiply $1,000 by 4% and the coupon is $40 a year. The example assumes the payments are made and uses annual amounts.
Calculate current yield from market price
The SEC’s Investor.gov glossary defines current yield using annual interest and the current price. At $1,000, $40 divided by $1,000 is 4%. At $800, the same $40 gives 5%. At $1,200, it gives about 3.33%. Each is a separate fictional price scenario. The figures isolate the effect of the price on the calculation.
Market interest rates can help explain a changing price. Suppose comparable new bonds offer larger payments for the same face value. Buyers may be willing to pay less for the older $40 payment. The SEC’s interest rate bulletin describes the usual inverse relationship between rates and fixed-rate bond prices. Credit risk and time to maturity can also influence the price, so keep the terms and issuer in the comparison.
Check what the yield counts
Current yield counts the annual coupon relative to the price. Suppose the $800 buyer holds the bond to maturity and receives the assumed $1,000 redemption payment. There would also be a $200 difference between the purchase price and the redemption amount. A buyer who pays $1,200 and receives $1,000 faces a $200 difference in the opposite direction. The length of time before redemption matters.
A yield-to-maturity calculation incorporates the scheduled interest and redemption payment over time. The return actually received depends on what is paid, the price and timing of any sale and relevant costs. Check which yield a quotation uses before comparing it with the coupon or with another bond’s quoted yield.
Sources & further reading
- SEC guide to corporate bonds
Explains corporate debt, coupon payments, maturity and the possibility of default.
- SEC bulletin on fixed-rate bond prices and interest rates
Explains why comparable fixed-rate bonds generally fall in price when market interest rates rise.
- SEC Investor.gov current yield definition
Defines the ratio of annual income from a bond to its current price.