What Does Yield Mean?

Bond yields typically come in three ways — coupon yield, current yield, and yield to maturity.

In reviewing the differences, assume you purchase a 4% bond with a face value of $1,000 for $900, maturing in five years. Here's a brief explanation of the three methods:

Coupon yield is the interest rate stated on the bond, which is determined by the issuing company based on prevailing rates at the time the bonds are sold. This is a fixed rate that does not change during the bond's life. In the example, the coupon yield is 4%.

Current yield is the return paid by the coupon interest on the bond's net purchase price. This yield will be higher than the coupon yield for bonds purchased at a discount and lower for bonds purchased at a premium. The current yield is calculated by taking the annual interest payment divided by the purchase price times 100. The current yield in the example is 4.44% ($40 interest divided by the $900 purchase price times 100).

Yield to maturity calculates the total return provided by the bond, factoring in interest payments and discounts or premiums. Yield to maturity calculations can be time consuming but can be approximated as follows: annual interest payment plus the average discount or minus the average premium divided by the average of the face value and current bond price times 100. In the example, the yield to maturity would be 6.32%, calculated as follows: $40 interest plus $20 average discount divided by $950 (average of $1,000 face value and $900 purchase price) times 100.