Bonds
Coupon, yield and the return you actually earn
The interest printed on a bond is not the same as the return from the price you pay.
A coupon describes the payment
A bond’s coupon is calculated on its face value. If you buy that bond at a different price, the coupon does not change simply because you paid more or less.
That is why two people can buy the same bond and experience different returns. The cash flows may be the same; their starting prices are not.
Yield brings the price into the picture
Yield to maturity, or YTM, relates the purchase price to the bond’s scheduled cash flows through maturity. It is more informative than looking at the coupon alone, but it still rests on assumptions.
YTM is not a guarantee of the return you will realise. It assumes the promised payments occur. The outcome from reinvesting coupons depends on the rates actually available, and an early sale can produce a different result. Taxes and transaction costs also change what you keep.
The same yield can hide different risks
In a post, I compared an unsecured bond from a stronger-rated issuer with a secured bond from a lower-rated issuer. Both showed the same yield. That did not make the investments interchangeable.
The first raises questions about the issuer’s ability to repay without specific asset security. The second adds questions about the quality of the security, competing claims and how recovery would work. Neither a rating nor collateral removes the possibility of loss.
Look at the structure underneath
Before choosing, review the rating rationale and outlook, the security documents, the maturity and any issuer redemption option. A call provision can change how long you receive the expected payments.
Also ask what selling before maturity would involve. Listing gives a trading venue; it does not create a buyer at your preferred price. A yield comparison that ignores access to money is incomplete.
Use yield to ask a better question
Rather than asking which number is higher, ask what you have to accept to earn it. Is it a different borrower, a longer commitment, a more complicated structure or less practical liquidity?
The useful comparison is between complete investments, including their risks and cash flows. The percentage on the screen is the beginning of that comparison.