Dividend and Income Investing

The single most important idea in bond pricing is a seesaw. A bond's payments are fixed — the coupon never changes. So if you pay less for the bond, those same payments represent a bigger return for you. Price down, yield up. Pay more, and the same payments represent a smaller return. Price up, yield down. They always move opposite.

Here is the whole thing in one example. A $1,000 bond pays a 5% coupon — $50 a year. Buy it at face value, $1,000, and you earn $50 on $1,000: 5%. Now imagine bad news hits the bond market and the price drops to $900. The coupon is still $50 a year. But now you earn $50 on only $900 invested — about 5.6%. The price fell, so the yield rose. If instead the bond were bid up to $1,100, your $50 on $1,100 is only about 4.5% — price rose, yield fell.

This is why rising interest rates hurt bonds (AP-206's duration lesson): when new bonds offer higher coupons, old bonds' prices fall until their yields match. Nobody overpays when the seesaw has already spoken. Remember it as a law of physics for bonds — it never breaks.

If price changes what you earn, then a bond needs one honest number that summarizes your total return — including the price you paid, every coupon you will collect, and the difference between what you paid and what you get back at maturity. That number is yield to maturity — YTM. It is the annual return you earn if you buy the bond today, hold it to the end, and collect everything as promised.

Run the numbers on that $1,000 bond, 5% coupon, 10 years to maturity, bought at $950. Each year you collect $50 on your $950 — that is 5.26% from coupons alone (current yield is exactly this: annual coupon divided by the price you paid). Plus, at the end, you receive $1,000 back — $50 more than you paid, spread over 10 years, worth roughly another 0.5% a year. Put them together and the YTM is about 5.7% — higher than the 5% coupon, because you bought at a discount.

The professional shortcut: YTM ≈ (annual coupon + yearly share of the price gain or loss) ÷ price. You will never compute it by hand on a test — calculators and bond quotes do it — but now you know what the quoted number means. It is your true annual return, all-in, if you hold to maturity. Compare bonds by YTM, never by coupon alone.

The coupon shapes a bond's personality. A high-coupon bond hands you most of your return early, as cash in hand every year — comfortable, and less sensitive to rate moves (remember duration: early payments mean lower duration). A low-coupon bond pays little along the way and returns most of your money at the end — cheaper to buy, twitchier when rates move.

Then there is the extreme: the zero-coupon bond, which pays no interest at all. You buy it at a deep discount — say $600 for a bond that repays $1,000 in twenty years — and your entire return is the price climbing toward face value over time. Zeros are the most rate-sensitive bonds in existence (all the money arrives at the very end), which makes them powerful tools for locking in a known future payout — say, a college bill in eighteen years — and dangerous to hold if rates are about to rise.

The pattern is universal: the later your money arrives, the more the bond's price swings with interest rates. Coupons are not just income — they are timing, and timing is risk.

One last vocabulary pair that makes bond quotes readable. A discount bond trades below face value — like our $950 example. Buy it, hold it, and you pocket the discount at maturity on top of the coupons; its YTM sits above its coupon rate. A premium bond trades above face value — say $1,080 for that same $1,000 bond. You overpay up front and get back only $1,000 at the end, so its YTM sits below its coupon rate.

Why would anyone pay a premium? Because the coupon is fat. A bond with an 8% coupon is worth paying extra for when new bonds only pay 4% — you are buying a stream of rich payments, and the premium is the price of admission. The YTM still tells the truth: whatever you paid, your actual return is the number the seesaw gives you.

Now the picture is complete: face value, coupon, price, and yield to maturity are four faces of the same deal. Read the YTM, and you know exactly what a bond pays you for your money. Next, AP-208 asks the other great bond question: will you actually get paid?

You know what a bond pays you — now, will the borrower actually pay? AP-208 "Credit Risk and Bond Ratings" covers default risk, the rating agencies, and credit spreads.

> Recommended Tools > > Watching yields move in real time makes the seesaw click — [Bankrate](#) posts daily bond and CD rates so you can see prices and yields shifting together. > > FTC disclosure: The Academy may earn a commission if you sign up through these links — it keeps the free lessons free.