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A bond's coupon rate is the actual amount of interest income earned on the bond each year based on its face value. A bond's yield to maturity (YTM) is the estimated rate of return based on the assumption it is held until maturity date and not called. Yield to maturity includes the coupon rate within its calculation. Investors are more likely to make investing decisions based on an instrument's yield to maturity than its coupon rate.

Suppose you purchase an IBM Corp. bond with a $1,000 face value, and it is issued with semi-annual payments of $10. To calculate the bond's coupon rate, divide the total interest annual interest payments by the face value. In this case the total annual interest payment = $10 x 2 = $20. The annual coupon rate for IBM bond is therefore, $20 ÷ $1000 = 2%. The coupons are fixed; no matter what price the bond trades for, the interest payments always equal $20 per year. For example if interest rates went up, driving down the price of IBM's bond to $980, the 2% coupon on the bond will remain unchanged.

The coupon rate is often different from the yield. A bond's yield is more accurately thought of as the effective rate of return based on the actual market value of the bond. At face value, the coupon rate and yield equal each other. If you sell your IBM Corp. bond at a $100 premium, the bond's yield is now equal to $20 / $1,100 = 1.82%. Assuming interest rates increased and the price of your bond fell to $980, your yield from selling the bond at a discount will be $20 / $980 = 2.04%  Thus, yield and price are inversely related.

Yield to maturity approximates the average return of the bond over its remaining term. A single discount rate is applied to all future interest payments to create a present value roughly equivalent to the price of the bond. The entire calculation takes into account the coupon rate; current price of the bond; difference between price and face value; and time until maturity. Along with the spot rate, yield to maturity is one of the most important figures in bond valuation.

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