A bond is a fixed set of payments
Buy a bond and you're buying a schedule: regular coupon payments and your face value back at the end. A $1,000 bond with a 5% coupon paid twice a year sends you $25 every six months. Those amounts don't change after the bond is issued.
The price is the only thing that moves. Investors pay whatever makes those fixed payments earn the going rate for that kind of bond. That going rate is the yield.
Why price and yield move in opposite directions
Say rates rise and new 10-year bonds now pay 6%. Nobody will pay $1,000 for your 5% bond when they could buy a 6% one at the same price. Your bond has to get cheaper until it also earns 6%. That happens at $925.61.
Now say rates fall to 4%. Your 5% coupon looks generous, and buyers will pay up to $1,081.76 for it. The coupons are the same in both cases. Only the price changed to line the bond up with the market.
Coupon rate, current yield and yield to maturity
These three get confused all the time. For the 5% bond priced at $925.61:
- Coupon rate is 5%. It's the coupon divided by face value, and it never changes.
- Current yield is 5.4%. It's the $50 annual coupon divided by the $925.61 price.
- Yield to maturity is 6%. It adds the $74.39 gain you get when the bond repays $1,000, spread over the 10 years.
Which yield to compare
When you line up two bonds, compare yield to maturity, or yield to worst if either can be called. Current yield flatters premium bonds, because it ignores the fact that you paid more than you'll get back. At a 4% market yield, the 5% bond costs $1,081.76 and shows a current yield above 4.6%, yet its yield to maturity is only 4%.
Coupon rate tells you about cash flow, not return. It's useful if you need a steady income amount, but it says nothing about what you paid.
Longer bonds swing more
Time to maturity decides how hard a rate change hits. A longer bond locks in its coupon for more years, so a rate change affects more payments. Here's a 5% bond at different maturities when yields move 1 point either way.
A 1-point rise costs the 2-year bond under 2% but the 30-year bond almost 14%. That's what duration measures. If you might sell before maturity, it's the number to check.
Discounts and premiums fade toward par
If yields stay put, a discount bond's price drifts up toward $1,000 as maturity gets closer. At a steady 6%, the 5% bond is worth $925.61 with 10 years left, $957.35 with 5 years left and $990.43 with one year left. At maturity it pays exactly $1,000.
Premium bonds drift down the same way. So a discount isn't free money and a premium isn't a loss. Both are just the price of a coupon that's out of line with today's rates.
What yield doesn't tell you
Yield to maturity assumes every payment arrives on time and that you reinvest coupons at the same rate. A higher yield often signals more credit risk, not a better deal. Callable bonds can be repaid early, which is why yield to call and yield to worst exist.
Want to test a bond yourself? Our bond price calculator prices it from a yield or solves the yield from a quote, and handles accrued interest and one call date.
Frequently asked questions
Do bond prices go up when interest rates go down?
Yes, for fixed-rate bonds. Lower market rates make existing higher coupons worth more, so prices rise. A 5% 10-year bond goes from $1,000 at a 5% yield to $1,081.76 at 4%.
If I hold a bond to maturity, do price changes matter?
Less, if the issuer pays everything as promised. You still get every coupon and the face value back. Price swings matter when you sell early or need to value your holdings.
Why do long-term bonds pay higher yields?
Often because investors want extra pay for tying up money longer and taking more interest-rate risk. It isn't guaranteed, and the gap changes over time.
What is a basis point?
One basis point is 0.01 percentage point. A move from 6.00% to 6.25% is 25 basis points.
Is a higher-yielding bond always better?
No. Higher yield usually means more risk: weaker credit, a longer term, a call feature or less liquidity. Compare those before comparing yields.
References
These sources support the method or guidance used for Bond Calculator. Verify time-sensitive rules at the source.
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