What is the Difference between Coupon and Yield Rate?
Investor prefers different types of asset class depending upon their investment style. There are various types of asset class available to the Indian investor such as equity, securities, real estate, mutual funds and bonds. Depending upon the risk behaviors and financial goals, one can invest in either of them. But with every asset there is a certain risk involved. The least risk related investment in all these options is bond.
A bond is an asset class where an investor lends their money to the government or corporation for a set period, with the promise of repayment of that money plus interest. A government bond is considered low–risk investments since the respective government backs them. There are basically two options available for the investor to invest in bonds i.e. Yield to maturity and coupon rates. Let us understand each one of them:
- Yield to Maturity: The other way to define is redemption yield. If an investment is held till the maturity date, the rate of return that it will generate will be yield to maturity. It is the estimated annual rate of return for a bond assuming that the investor holds it till its maturity date.
- Coupon Rate: A coupon rate is basically the rate of interest paid by the bond issuers on the bond face value. It is simply the annual coupon payment paid by the issuer relative to the face value.
Let’s us understand the difference between the yield to maturity and coupon rate
- YTM is basically the rate of return estimated on the bond if it is held until the maturity date. But the coupon rate is the amount of interest paid per year. It is expressed as a percentage of the face value of the bond. For instance, if you hold Rs 10,0000 bond with a coupon rate of 5%, then you will receive Rs 5000 every year.
- While calculating the YTM, various things are considered coupon rate, bond price, time remaining until maturity and the difference between the face value and price. It is quite a complex process. While the coupon rate is a basic simple process, as one needs to calculate the rate of interest to be paid on the face value.
- There is also called zero coupon bonds, which don’t give you any interest but are sold to the investor at the face value. YTM does include the coupon rate in its calculation.
Before investing in these bonds, Investors need to understand the pros and cons of investing in them.
- Rate of returns: Those who invest in bonds get a fixed rate of interest after maturity.
- Less risky: Bonds are less risky compared to other asset class, as the government hardly default on its obligation.
- Clear rating: Unlike other asset class, which hardly have any fixed rating. Bonds do have a fixed rating and an investor buys them depending upon those ratings.
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*Mutual fund investments are subject to market risks. Please read the scheme information and other related documents carefully before investing.