Bond Yield vs. Bond Return: They Are Not the Same Thing

Start With a Simple Bond

The bond has:

• Face value: $1,000
• Coupon rate: 4%
• Annual interest payment: $40
• Five years until maturity

For simplicity, this bond pays its coupon once a year. Many real bonds pay twice a year. The concepts stay the same.

Buy it at $1,000 and you collect $40 a year. At maturity you get your $1,000 back, assuming the issuer pays everything it promised. That looks like a 4% return. But the bond has several different “yields,” and none of them is automatically the return you earn.

Coupon Rate Is Not the Bond’s Market Yield

The coupon rate is set when the bond is issued. It is the annual coupon divided by face value.

$40 ÷ $1,000 = 4%

The $40 never changes. Once the bond trades in the market, its price moves above or below $1,000, but the coupon stays fixed. That gap between a fixed payment and a moving price is where yield comes from.

Current Yield

Current yield is the annual coupon divided by the bond’s current price.

Say the price of the bond falls to $900. The bond still pays $40.

See What Is a Bond? for reasons why the bond price may rise or fall.

$40 ÷ $900 = 4.44%

If the bond price increases to $1,100:

$40 ÷ $1,100 = 3.64%

Same bond. Same $40 coupon. Different price, different yield.

When a bond’s price falls, its yield rises. When its price rises, its yield falls.

Current yield is easy to calculate, but it ignores something. It says nothing about the gain or loss between what you pay and what you get back at maturity.

Yield to Maturity

Assume yields have risen and bond prices have fallen. You can now buy the original $1,000 bond at a discounted price of $900. You still collect the $40 annual coupon, and at maturity you receive the bond’s $1,000 face value. You paid $900 for that repayment, so you gain $100 on top of the coupons.

Yield to maturity (YTM) captures both the coupons and that gain or loss at maturity. It also accounts for when each payment arrives.

The current yield is 4.44%. The YTM is about 6.4% a year, because you also collect the move from $900 up to $1,000.

The reverse happens above face value. Buy the same bond at $1,100 and the YTM is only about 1.9%. You still collect $40 a year, but you get back $100 less than you paid.

These examples assume one coupon a year, matching our simplified bond. Many Canadian bonds pay semi-annually, so a standard bond calculator may give slightly different figures.

Four Numbers People Call “Yield”

When you see the word yield, check which one is being quoted.

For a single bond, YTM is the most complete of these. It is still not necessarily the return you will earn.

What Is Bond Return?

Return looks backward over a specific holding period.

Total return = (income + ending price − starting price) ÷ starting price

For bonds, it helps to keep income and price change separate. They can push in opposite directions.

A 4% Yield Can Produce a Negative Return

Buy the original 5-year bond for $1,000.

One year later, the bond has four years remaining. In this scenario, assume yields on comparable bonds have risen from 4% to 6%.

Your bond still pays only $40 a year, so no one will pay $1,000 for it. At a 6% market yield, its price falls to about $931.

You collected $40 in interest and lost about $69 in market value.

($40 + $931 − $1,000) ÷ $1,000 = −2.9%

Round that to −3%. You started the year holding a bond yielding about 4% and finished it down about 3%. There is no contradiction. The price drop was larger than the coupon.

Falling Yields Produce the Opposite Result

Now suppose yields fall. One year after purchase, the bond again has four years remaining, but comparable bonds yield 3%.

Your $40 coupon now beats what new bonds pay. The price rises to about $1,037.

($40 + $1,037 − $1,000) ÷ $1,000 = 7.7%

The bond started the year yielding about 4% and returned about 7.7%. You collected $40 in interest and about $37 in price gain.

Why Prices Move Opposite to Yields

Suppose newly issued bonds of the same risk and maturity pay more than your bond. No one will pay $1,000 for your $40 coupon when $1,000 buys more income elsewhere.

Your bond has to get cheaper. Once the price falls far enough, the $40 coupons plus the $1,000 repayment give a buyer a return that matches the new bonds.

The reverse also holds. When market yields fall, your fixed payments look better, and buyers will pay more for them.

• Market yields rise → existing bond prices fall
• Market yields fall → existing bond prices rise

Maturity Matters

Consider two bonds with similar coupons. Bond A matures next year. Bond B matures in 20 years.

If yields rise, Bond A holds you to its old coupon for a short time. Then you get your principal back and reinvest at the new, higher rates. Bond B keeps paying a below-market coupon for two decades. Its price has to fall much further.

All else equal, longer-term bonds react more to changes in interest rates. The standard measure of this sensitivity is duration. Roughly speaking, a bond with a modified duration of 7 should fall about 7% if its yield rises by one percentage point. That is an approximation, not an exact rule. It explains why two bond funds can react very differently to the same rate change.

What If You Hold the Bond Until Maturity?

Suppose the bond falls to about $931 after yields rise to 6%. Sell then, and the loss is locked in.

Keep it, and nothing about the promised payments changes. You still collect $40 a year and $1,000 at maturity, assuming no default. As maturity approaches, the price generally moves back toward $1,000. This is called pull to par.

Two separate numbers describe what happens.

Looking forward from $931, the remaining cash flows imply a YTM of about 6%. You own the same bond a new buyer would, so you have the same forward YTM they do. That is why the price fell that far. It had to match what new bonds offer.

Looking back from $1,000, your original cash flows were −$1,000 today, $40 a year, and $1,000 at maturity. If the issuer pays everything it promised, the yield on that stream is 4% a year. That is the yield you bought at. It depends only on those contractual cash flows. The interim market price does not enter into it.

These are two different calculations. The 6% starts from the $931 market value. The 4% starts from your $1,000 purchase.

The price drop is where the loss shows up. A new $1,000 bond at 6% pays $60 a year. Yours pays $40. That $20 shortfall over four years, discounted at 6%, is worth about $69. That is the $69 the price fell.

Holding to maturity means you never have to sell at the low. It does not reverse that loss. Assuming no default, your original cash flows still produce the 4% you bought at. Your realized compound return can differ somewhat, depending on what you earn when you reinvest the coupons.

Yield to Maturity Is Not a Guarantee

YTM condenses a bond’s price and promised cash flows into one annual rate. It is not a forecast of your return. Outcomes differ for several reasons:

• Default. The issuer may miss some or all payments.
• Selling early. The price you get may be higher or lower than you expected.
• Reinvestment. Coupons you receive may be reinvested at different rates than the bond’s original yield.
• Callable bonds. The issuer may repay early, which changes the cash flows.
• Taxes and fees. What you keep may differ from the quoted yield. See interest vs. capital gains for how Canadian tax treatment works.
• Currency. A foreign bond can gain or lose value in Canadian dollars even when the bond itself performs as expected.

What About Bond ETFs?

An individual bond has a maturity date. A broad bond ETF generally does not. As bonds in the fund mature or leave the index, the fund replaces them. (Target-maturity ETFs are an exception.)

So “I’ll hold the ETF until maturity and get my $1,000 back” does not work. There is no single maturity date and no single repayment.

A bond ETF may show a distribution yield, a trailing yield, an average YTM, or other measures. These describe the fund’s current income or expected cash flows. None of them is next year’s total return. That depends on both the income the bonds produce and the change in their market value.

A bond ETF yielding 4% can have a negative year. It can also return well above 4% if falling yields push prices up.

Rising Yields Hurt Today and Help Later

Rising yields have two effects on a bond portfolio.

First, existing bond prices fall. That is an immediate loss.

Second, the portfolio can reinvest coupons and maturing principal at the new, higher yields. That improves future returns.

Falling yields work in reverse. Existing bonds gain value now, but new money earns less.

This matters most for bond funds and ETFs, which keep replacing maturing bonds instead of reaching one final maturity date.

Yield Is the Starting Point. Return Is the Outcome.

Two questions keep the concepts apart.

Yield asks: Given this bond’s price and cash flows today, what annual rate does it offer?

Return asks: Given what I paid, the income I received, and what the bond was worth later, how much did I make or lose?

That is why a bond yielding 4% can return about −3%, +4%, or +8% over a particular year. The missing piece is price. And because prices and yields move in opposite directions, that relationship is the core of bond arithmetic.

Key Takeaways

• Coupon rate, current yield, and yield to maturity are different measurements.
• A quoted yield is not necessarily the return you will earn over your holding period.
• Total return is interest income plus the change in the bond’s price.
• When market yields rise, existing bond prices generally fall. When yields fall, prices generally rise.
• Longer-duration bonds move more when yields change.
• Holding an individual bond to maturity, selling early, and owning a bond ETF are three different experiences.
• Yield describes the investment at today’s price. Return describes what actually happened.

Frequently asked questions