Introduction
Yield is one of the most important concepts in fixed income. It helps investors translate a bond’s price and cash flows into comparable return measures, but different yield measures answer different questions.
What Is a Bond Yield?
A bond’s coupon tells you the contractual interest payment. Yield tells you about return relative to the price paid. This distinction matters because bonds frequently trade above or below face value.
No single yield measure answers every question. Investors use several measures depending on whether they care about current income, return to maturity or the effect of embedded call options.
Current Yield
Current Yield = Annual Coupon / Current Market Price. A bond paying $50 per year and trading at $950 has a current yield of 5.26%.
Current Yield = Annual Coupon / Current Market Price
Current yield is simple and useful for comparing cash income, but it ignores capital gains or losses between the purchase price and maturity value, the time value of money and reinvestment.
Yield to Maturity (YTM)
Yield to maturity is the discount rate that equates the bond’s current price with the present value of all promised coupons and principal if the bond is held to maturity. It is effectively an internal rate of return based on the contractual cash flows.
YTM is more comprehensive than current yield, but it is not a guaranteed realized return. It assumes the issuer makes the promised payments and, in standard interpretation, that coupons can be reinvested at the same yield.
Yield to Call (YTC)
Callable bonds allow the issuer to redeem the bond before final maturity under specified conditions. Yield to call calculates the return assuming the bond is called on a particular call date at the contractual call price.
This is especially relevant when a bond trades above par and market rates have fallen, because the issuer may have an incentive to refinance expensive debt.
Yield to Worst (YTW)
Yield to worst is the lowest yield among specified contractual redemption scenarios, typically comparing yield to maturity with yields to eligible call dates, assuming no default.
YTW is useful because it forces the investor to consider an unfavorable exercise of embedded options rather than relying only on final maturity.
Yield Measures Compared
A discount bond can have a current yield below its YTM because the investor may also earn a capital gain as price converges toward par at maturity. A premium bond can show the reverse effect because part of the premium is lost as maturity approaches.
For callable bonds, YTC and YTW can be more informative than YTM when an early redemption is economically plausible.
Which Yield Should You Use?
Use current yield when the focus is immediate coupon income. Use YTM for a standardized hold-to-maturity return measure on a non-defaulted bond. Use YTC when call risk matters. Use YTW as a conservative contractual yield comparison for bonds with embedded issuer options.
Professional analysis normally considers yield together with duration, credit spreads, liquidity, optionality and scenario analysis.
Key Takeaways
Coupon rate is not the same as yield. Current yield focuses on income, YTM incorporates price and maturity cash flows, YTC incorporates early call assumptions, and YTW highlights the least favorable contractual redemption yield.
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