William Lako: Understanding the impact of coupon rates and yield to maturity

With interest rates moving higher over the last 18 months, many investors are concerned that they are not earning anywhere near market rate on their bonds. They’re holding bonds at 3.25 percent while new bonds are yielding around 4.60 percent. In some but not all cases, the issue is that the coupon on the bond is being confused for the yield to maturity.

A bond’s coupon rate represents the yearly interest paid by the bond with respect to its face value. Say the U.S. government issues a bond with a face value of $100,000. The interest rate on this bond is set at 3.25 percent per year, called the coupon rate. An investor holding this bond will receive $3,250 per year as interest payments. It does not matter if the investor paid par value ($100,000) for the bond or bought it at a discount to par value. Let’s say they paid $91,480; the coupon is still 3.25 percent of face value, and the investor still receives the $100,000 face value at maturity.