Current Yield vs. Yield to Maturity: What They Actually Measure
Current yield tells you how much income a bond generates relative to its market price right now. The formula is simple: annual coupon payment divided by the price you paid. A $1,000 face value bond with a 6% coupon bought at $960 has a current yield of 6.25% ($60 / $960). It ignores what happens at maturity.
Yield to maturity (YTM) is the total annualized return you earn if you hold the bond until it matures and reinvest every coupon at the same rate. It factors in coupon income, the difference between your purchase price and face value, and the time value of money. For that same $960 bond maturing in 8 years, the YTM would be about 6.6% because you also gain $40 in principal at maturity.
Use current yield for a quick income snapshot. Use YTM when comparing bonds with different maturities, coupon rates, or purchase prices. YTM is the standard benchmark bond investors rely on for apples-to-apples comparisons.
Premium vs. Discount Bonds: How Purchase Price Affects Your Yield
| Characteristic | Discount Bond | Par Bond | Premium Bond |
|---|---|---|---|
| Purchase Price | $950 | $1,000 | $1,050 |
| Face Value | $1,000 | $1,000 | $1,000 |
| Coupon Rate | 5.00% | 5.00% | 5.00% |
| Current Yield | 5.26% | 5.00% | 4.76% |
| YTM (10yr) | 5.73% | 5.00% | 4.31% |
| Capital Gain/Loss | +$50 | $0 | −$50 |
| Why It Trades Here | Coupon below market rates | Coupon equals market rates | Coupon above market rates |
Discount bonds trade below face value because their coupon rate is lower than prevailing market rates. You get a capital gain at maturity, which boosts the YTM above the current yield. Premium bonds are the opposite—higher coupons but a guaranteed capital loss at maturity that drags the YTM below the current yield.
How Interest Rates Affect Bond Prices
Bond prices and interest rates move in opposite directions. When the Federal Reserve raises rates, newly issued bonds offer higher coupons, making your existing lower-coupon bond less attractive. Its market price drops until its effective yield matches the new environment. The reverse happens when rates fall—your older, higher-coupon bond becomes more valuable.
Duration measures this sensitivity. A bond with a 10-year duration loses roughly 10% of its value for every 1% rate increase. Shorter-term bonds (2–3 years) are far less volatile—a 1% rate hike only drops their price by about 2%. If you expect rates to rise, shorter duration reduces your risk. If you expect rates to fall, longer duration amplifies your gains.
Zero-coupon bonds are the most rate-sensitive because all of their return comes at maturity—there are no interim coupon payments to reinvest at the new higher rate. A 30-year zero-coupon bond can swing 25–30% on a 1% rate move.
Tax Treatment of Bond Income
Coupon payments on corporate bonds are taxed as ordinary income at your marginal federal rate, which can be as high as 37%. If you buy a bond at a discount and hold to maturity, the difference between purchase price and face value is taxed as a capital gain—long-term if held over a year, which caps the rate at 20% for most investors.
Municipal bonds are the main exception. Interest from munis is exempt from federal income tax, and if the bond is issued in your state, it's often exempt from state tax too. At a 32% marginal rate, a 3.5% muni yield equals a 5.15% taxable yield—use a tax-equivalent yield calculator to compare directly.
Treasury bonds split the difference: interest is subject to federal tax but exempt from state and local taxes. For investors in high-tax states like California or New York, this can add 0.3–0.5% in effective yield compared to a corporate bond with the same stated rate.
To compare municipal and taxable bond yields side by side, use the tax-equivalent yield calculator. To see how reinvesting your coupon payments grows over time, try the compound interest calculator.