Making Sense Of Coupons, Yields And YTMs

Do not let jargon spook you. Here, we help you decipher different terms used in the bond market

- Aarati Krishnan

With stock market returns waning, many retail investors are today seeking comfort in the fixed returns offered by bonds. The fund crunch for NBFCs has prompted many of them to tap the market with public issues of bonds. Apart from this, many investment platforms offer recommendations on bonds traded in the secondary markets. But bond recommendations are often accompanied by an alphabet soup of jargon. Here’s making sense of the terms.

Coupon rate

The coupon rate is the actual interest expressed in percentage terms that the borrower proposes to pay you at annual intervals. If you are investing in bonds with a face value of ₹1,000 and a coupon rate of 8.5 per cent, you will receive ₹85 by way of interest from the issuer every year. The higher the coupon rate, the higher the return you will earn from the bond. However, do remember that an issuer’s willingness to pay a high coupon rate on a bond is also an indicator of how risky he is perceived to be by the market.

Effective yield

When the issuer of a bond pays out the interest at a monthly, quarterly or half-yearly frequency, he usually advertises an ‘effective yield’ that is higher than its coupon rate. Calculations of effective yield assume that when you receive the interest at monthly, quarterly or halfyearly intervals, you will re-invest this money elsewhere at the same rate to earn returns from it.