Bond yields

A bond yield is a measure of the return that an investor will receive on their capital. There are several different ways in which bond yields can be defined, depending on what you are trying to measure.

The nominal yield (also called the coupon rate or coupon yield) is the annual interest rate set when the bond is issued. For most conventional bonds, this does not change (floating-rate bonds, where the interest resets periodically to reflect some reference rate, are an exception). Unless you are buying the bond at face value (eg, when it’s first issued), nominal yield doesn’t reflect any return you receive. But it can tell you something about the properties of the bond and how it may behave in different market conditions.

The current yield (also known as running yield, income yield and market yield) is the annual interest divided by the current market price. This tells you the regular income you will receive if you purchase at this price. However, this is not the same as the total return you’ll make over the life of the bond.

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The yield to maturity (also referred to as the redemption yield) is the bond’s annual rate of return if an investor holds it until it matures. It takes account of all interest payments and the principal. This makes it the correct measure of the total return you can expect if you don’t sell before maturity.

To see how these fit together, consider a bond with a face value of £100 that was issued with a 5% interest rate (the nominal yield) and matures in two years. It now trades at £95, meaning that its current yield is 5.26% (£5 / £95). An investor who holds to maturity gets £5 in interest each year and the principal of £100. That’s a total of £110, giving an annualised return of 7.61% on £95 invested now (the yield to maturity).

Alternatively, assume that the same bond were trading at £105. It would still have a nominal yield of 5%, but its current yield would be 4.76% and its yield to maturity would be just 2.35%.

See Tim Bennett's video tutorial: Bond basics.