Yield

Every yield measure starts from a market price. Given the cash flows an instrument promises or is expected to pay, the yield is the rate that links those cash flows to what the market currently charges for them. For a bond, yield to maturity is the single discount rate that makes the present value of all remaining coupons and principal equal to the full price. For a share, dividend yield divides the annual dividend by the current price.

Because the cash flows are given, price and yield carry the same information in different units. A trader who says a note changed hands at a yield of 4.25% has also stated its price. In fixed income, yield is commonly used as a synonym for the market discount rate, and that usage is accepted: rising yields mean rising discount rates and falling prices.

Yield to maturity is a promised yield. The holder earns it only under three conditions: the bond is held until it matures, the issuer makes every payment in full and on time, and every coupon is reinvested at the same yield. Break any one of them and the realized return differs. Sell early after rates rise and the price loss pulls the return below the yield; reinvest coupons at lower rates and the return again falls short.

When a holding-period result is meant, analysts attach a label, such as horizon yield or realized yield: the annualized return actually earned over the investor's horizon. Without such a label, yield refers to a forward-looking figure implied by the price.

Current yield divides the annual coupon by the bond's flat price. It ignores the gain or loss as the price moves toward par, and it ignores the timing of payments. Yield to maturity captures both, by treating the bond as a series of cash flows priced at one rate. For callable bonds, yield to call assumes redemption at a call date, and yield to worst is the smallest yield among the call dates and maturity.

Against the coupon rate, the measures line up predictably. For a bond priced at a premium, the coupon rate exceeds the current yield, which exceeds the yield to maturity; for a discount bond the order reverses; at par, on a coupon date, all three are equal. Between coupon dates, close to par, they can be almost identical and the ordering may not hold exactly.

Expect to convert prices into yields and back, to compare yields quoted on different bases, and to explain what a change in yield does to price. Yields stated on a semiannual bond basis must be converted to an effective annual figure before they are compared with an annual-pay bond. Spreads, such as the difference between a corporate bond's yield and a government benchmark, are quoted in basis points.

Above all, keep the vocabulary straight. Use yield for measures implied by a current price, interest rate for a rate agreed in a contract, and return for the outcome of holding an investment. A question that asks for a realized return cannot be answered with a yield to maturity unless all three conditions for earning it hold.