In more detail
A $1,000 bond with a 5% coupon pays $50 a year, often as two $25 payments. Its market price moves inversely to interest rates: when new bonds pay more, an existing bond must sell below face value to offer the same return, and the reverse. The yield to maturity combines the coupon, the price and the time left; longer maturities move more for the same rate change. Bonds also carry credit risk, which ratings agencies grade, and riskier issuers must pay higher coupons.
Why it matters
Bonds are called "safe", but a bond fund or a bond sold before maturity can lose value when rates rise. Held to maturity, a bond from an issuer that does not default returns its face value regardless of price swings in between.
Example
A 10-year, $1,000 bond with a 5% annual coupon:
| Market rate | Bond price |
|---|---|
| 4% | $1,081.11 |
| 5% | $1,000.00 |
| 6% | $926.40 |
At $926.40 the current yield is 50 / 926.40 = 5.40%, while the yield to maturity is 6% because it also counts the $73.60 gain at maturity.