Your broker shows you two bonds. Both pay a 5% coupon. One costs $950 with three years left; the other costs $1,020 with ten years left. The coupon rate calls it a tie, and current yield hands a narrow win to the cheaper bond. Neither answer is the one you should trade on, because neither accounts for the lump sum each bond repays at maturity or how long your money stays locked up earning it. Yield to maturity folds price, coupon, and time into a single annualized number — and once you can read it, bond quotes stop being a wall of percentages and start being comparable.
The Three Yields, From Simplest to Complete
Every bond quote carries layers of yield math. Start with the two simple ones so you can see exactly what the third adds.
1. Coupon yield: the rate printed on the bond
A bond's coupon is the annual interest it promises, stated against its face (par) value — usually $1,000. Divide the annual coupon by the face value and you have the coupon yield:
Coupon yield = Annual coupon payment / Face value
A $1,000 bond paying $50 a year has a 5% coupon yield, and that number never moves for the life of the bond. It is useful for one thing only: telling you the size of the checks relative to par. It says nothing about the return you earn, because you may not pay par.
2. Current yield: the coupon measured against what you pay
Current yield swaps face value for market price:
Current yield = Annual coupon payment / Market price
Pay $950 for that 5% bond and your current yield is 5.26%. Pay $1,050 and it falls to 4.76%. This is the famous inverse relationship between price and yield in one line of arithmetic: as the price rises, the fixed coupon buys you less return, and vice versa. A textbook example makes the same point — a 4.5% bond bought at par that later trades at 103 ($1,030) sees its current yield slip to about 4.37%.
Current yield is the right number in exactly one situation: you plan to sell before maturity and mostly care about income versus price right now. For anything else, it is a stepping stone.
3. Why both fall short
Neither measure accounts for the time value of money, the maturity value you receive at the end, or how often coupons arrive. A bond bought at a discount hands you a built-in capital gain when it redeems at full face; a premium bond hands you a built-in loss. Current yield books neither. Compare two bonds on current yield alone and you are comparing their coupons while ignoring their endings — which is exactly where discount and premium bonds differ most.
What Yield to Maturity Actually Measures
Yield to maturity (YTM) is the discount rate that makes the present value of all of a bond's remaining cash flows — every coupon plus the principal repaid at maturity — equal to its current price. In plain terms, it is the single annualized return you earn if you buy at today's price and hold to the end, under the assumptions the fine-print section covers.
Solving for the exact YTM takes trial and error (a financial calculator or spreadsheet does it instantly), but a pencil-and-paper approximation gets you close:
YTM ≈ (C + (FV − PV) / t) / ((FV + PV) / 2)
- C = annual coupon payment
- FV = face value
- PV = current price
- t = years left to maturity
The numerator adds each year's coupon to each year's slice of the discount (or subtracts each year's slice of the premium); the denominator averages what you paid with what you get back. Work it for a $1,000-face bond with five years left, $100 annual coupons, priced at $927.90:
- Yearly discount slice: ($1,000 − $927.90) / 5 = $14.42
- Numerator: $100 + $14.42 = $114.42
- Denominator: ($1,000 + $927.90) / 2 = $963.95
- Approximation: $114.42 / $963.95 ≈ 11.87%
A solver puts the exact YTM at 12% — the approximation lands within a few basis points, close enough to rank bonds before you run the precise number.
The approximation also teaches the rule you will use forever:
- Buy at par — YTM equals the coupon rate. With no gain or loss at maturity, the coupons are the whole return.
- Buy at a discount — YTM sits above the coupon rate. Coupons plus price accretion.
- Buy at a premium — YTM sits below the coupon rate. Coupons minus price erosion.
Why YTM Beats Current Yield When You Compare Bonds
Return to the opening pair. Bond A: 5% coupon, $950, three years left. Bond B: 5% coupon, $1,020, ten years left. Current yield says A 5.26% versus B 4.90% — a modest edge for A. Now run the approximation:
- Bond A: ($50 + $50 / 3) / $975 = $66.67 / $975 ≈ 6.84%
- Bond B: ($50 − $20 / 10) / $1,010 = $48 / $1,010 ≈ 4.75%
YTM turns a 0.36-point gap into a two-point gap, because it counts what current yield skips: A's $50 discount arrives over just three years, supercharging the annualized return, while B's $20 premium drags across a full decade. Same coupons, wildly different economics — that is the comparison YTM exists to make.
One caution: YTM annualizes, but it does not equalize risk. Of two bonds with the same YTM, the longer-dated one swings harder when rates move, and the lower-rated one carries more default risk. Use YTM to rank returns, then check maturity and credit quality before you buy.
The Fine Print: Three Assumptions Behind Every YTM Quote
YTM is an estimate wearing a precise number's clothes. It assumes three things, and reality routinely breaks the third:
- You hold to maturity. Sell early and the market price at sale — not the face value — decides your return. This is the one case where current yield deserves your attention instead.
- Every payment arrives on time. Default risk lives outside the formula. When one bond's YTM towers over a similar bond's, the market is usually pricing doubt about repayment, not offering free money.
- You reinvest every coupon at the YTM rate. This is the heroic one. Rates drift constantly, so reinvesting each coupon at exactly the original YTM is virtually impossible. Your realized return lands above or below the quoted YTM depending on where rates actually go.
Two more things the number ignores: taxes and brokerage costs. Your after-tax, after-fee return is always lower than the quote. Treat YTM as the market's standardized yardstick for comparing bonds — which is what it is for — not as a promise of what lands in your account.
What Moves YTM After You Buy
Here is the confusion to avoid: once you own the bond, your locked-in YTM does not change. What changes is the YTM on offer to the next buyer. If market rates rise, your fixed coupons look stingy, your bond's price falls, and a buyer at that lower price earns a higher YTM than you locked in. If rates fall, your bond's price rises and its YTM-to-a-new-buyer falls.
That is why rising rates feel like losses on bonds you never sold — your statement marks the position at the new lower price — even though every coupon and the maturity payment arrive exactly as promised. Hold to maturity and the interim price swings wash out; sell into a rate spike and they become real. Duration, the standard measure of that price sensitivity, grows with maturity, which is why long bonds whipsaw while T-bills barely budge.
The Relatives: YTC, YTW, BEY, and EAY
Yield to call and yield to worst
Many corporate and municipal bonds are callable: the issuer can redeem them early, typically when falling rates let it refinance cheaper — precisely when you would most like to keep your high coupon. For these bonds, YTM's hold-to-maturity assumption is optimistic fiction.
Yield to call (YTC) runs the same math with the first call date and the call price substituted for maturity and face value. Yield to worst (YTW) is simply the lower of YTM and YTC — the most conservative return the bond can deliver. For a premium callable bond, YTC is usually the binding number, and it can sit well below the advertised YTM. Before you buy any callable bond, find its worst yield; the standard fixed-income data screens publish YTC and YTW next to YTM so you rarely compute them yourself.
Bond equivalent yield versus effective annual yield
Most bonds pay coupons twice a year, which raises an annualization question. Take a bond whose semiannual YTM is 5.979%:
- Bond equivalent yield (BEY) doubles it: 5.979% × 2 = 11.958%. Simple, and the standard for quote screens — but it ignores compounding between the two payments.
- Effective annual yield (EAY) compounds it: (1.05979)² − 1 = 12.32%. The extra compounding period is real money, so EAY always exceeds BEY.
When you stack a semiannual bond against an annual-pay bond, a CD, or a savings account, EAY is the apples-to-apples number. When you read a dealer quote, you are usually looking at a BEY-style YTM. Know which one is in front of you before you compare across product types.
Clean Price Versus Dirty Price: The Accrued-Interest Surprise
Coupons accrue daily but pay periodically, so between payment dates the seller has earned part of the next coupon. The buyer compensates the seller for those elapsed days through accrued interest — and bond markets quote two prices to keep it visible:
- Clean price — the quoted price, excluding accrued interest. This is what terminals and quote screens show.
- Dirty (invoice) price — clean price plus accrued interest. This is the cash that actually changes hands at settlement.
First-time buyers often panic when settlement costs more than price times quantity. It should: the extra is accrued interest you will recover in full at the next coupon date. The bookkeeping moral matters more than the cash surprise — that extra is not part of your bond's cost. It is interest income you purchased, and your books should say so from day one.
Booking Your Bonds: Premium, Discount, and Accrued Interest in the Ledger
A bond position touches your books three ways: the purchase splits cost from accrued interest, each coupon splits recovered accrual from new income, and any premium or discount amortizes over the bond's life so your interest income reflects YTM economics instead of lumpy coupon dates. In a plain-text ledger, the purchase and first coupon for a discounted bond look like this:
2026-10-20 * "Buy 1000-face 5 percent bond at 950 plus accrued interest"
Assets:Investments:Bonds:Bond-A 950.00 USD
Assets:Investments:Accrued-Interest 12.50 USD
Assets:Checking:Operating -962.50 USD
2026-11-01 * "Semiannual coupon 25.00 - recover accrual, book income"
Assets:Checking:Operating 25.00 USD
Assets:Investments:Accrued-Interest -12.50 USD
Income:Interest:Bonds -12.50 USDSeparating the $12.50 accrual from the $950 cost at purchase keeps your cost basis clean for the eventual sale or redemption, and amortizing the $50 discount into income each period spreads the built-in gain across the bond's life instead of dumping it all at maturity. That steady-income view is also what lets you check your broker's YTM figure against your own books: if the economics and the ledger disagree, one of them has a data-entry error, and it is usually the ledger.
Start with your next bond purchase: ask the quote screen for YTM and — if the bond is callable — yield to worst, run the approximation to make sure the ranking makes sense, and book the purchase with the accrual split out. Three numbers and one clean entry, and you will know what the bond earns, what could go wrong, and where every dollar sits.
