You will be able to tell the coupon rate from the yield and explain why the two differ once a bond trades.
Hui Min's colleague mentions over lunch that he bought a bond "yielding almost 4.5%". Hui Min looks it up that evening and finds the bond's coupon is 4%. She assumes he got the number wrong. He didn't. He was quoting a different number, and both figures describe the same bond.
This lesson is about that gap. Once you can tell the coupon from the yield, half the confusing numbers in bond adverts and bank statements stop being confusing.
In lesson 1.1, A bond is a loan with a fixed timetable, you met the coupon: the rate the borrower pays on face value. A 4% coupon on S$1,000 of face value pays S$40 a year, and it keeps paying S$40 a year until maturity. That figure was set the day the bond was issued and it is written into the terms.
The price of the bond is not fixed. Many bonds can be bought and sold between investors before they mature, and the price moves around. Bond prices are quoted per 100 of face value, so a price of 90 means you pay S$900 for S$1,000 of face value, and a price of 110 means you pay S$1,100.
So the S$40 a year is certain, but what you hand over to get it depends on when you buy. And the return on your money depends on what you hand over. That is the whole reason the coupon and the yield come apart.
The simplest yield is the current yield: the yearly coupon divided by the price you pay. It answers one question. For every dollar I put in today, how much coupon do I get each year?
Take the 4% coupon bond with made-up prices. Bought at 100, the current yield is 4 divided by 100, which is 4%. Bought at 90, it is 4 divided by 90, which is about 4.44%. That is roughly what Hui Min's colleague was describing: he paid less than face value, so the same S$40 is a bigger slice of what he spent. Bought at 110, the current yield is 4 divided by 110, about 3.64%.
The pattern runs one way. The coupon stays put, so when the price goes down the current yield goes up, and when the price goes up the current yield goes down. You will see the full version of that idea in module 2, where it explains why bond prices fall when interest rates rise.
Current yield is a useful first look, but it ignores something real. If you buy a bond below face value and hold it to maturity, you get the full face value back, not what you paid.
Stay with the colleague's purchase. He paid 90 for a bond that repays 100 at maturity. Suppose, as an example, it matures in three years. On top of the S$40 coupons each year, he collects a gain of S$100 per S$1,000 of face value at the end. The current yield of 4.44% counts the coupons and nothing else, so it understates what he will earn if all goes to plan.
The opposite happens when you pay more than face value. Buy at 110 and you get back only 100 at maturity, so you lose S$100 per S$1,000 along the way. The current yield of 3.64% overstates your return in that case.
The figure that folds the coupons and that gain or loss into one yearly rate is yield to maturity. It gets a lesson of its own, lesson 2.2, Yield to maturity in plain words. For now, remember the direction: a discount adds to your return, a premium takes away from it.
Even yield to maturity is a number on paper. Three things outside the bond change what lands in your account.
The first is fees. Buying a bond through a broker or a bank can involve commissions, platform charges or a spread between the buying and selling price. As a made-up example, a S$25 fee on a S$1,000 purchase is 2.5% of your money gone on day one, which would eat most of a year's coupon on a 3% bond. Small holdings feel fees the most.
The second is tax. How interest income is treated for individuals in Singapore depends on the type of investment, so check the current rules on the IRAS website for the instrument you hold rather than assuming the answer.
The third is what you do with the coupons. A coupon that lands in a savings account paying very little adds less over the years than one you put back to work at a better rate. The compounding tables from How money works, lesson 2.4, Build a compounding table in a spreadsheet, show how large that difference becomes over a long holding.
So when you see a yield figure, ask which one it is. A coupon rate tells you the cash per year on face value. A current yield tells you the cash per year on what you paid. Neither tells you the full return, and none of them is net of your own fees.
The quickest way to make this stick is to run the numbers on one bond at three prices and watch the current yield move. Use a bond with a different coupon from the one above so you work it out fresh, and keep your answers, because you will reuse them in module 2.
Using made-up figures, work out the current yield on a 3% coupon bond bought at 95, at 100 and at 105, and explain the pattern in one sentence.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).