Current Yield vs Yield to Maturity
Current yield measures the annual coupon income of a bond as a percentage of its current market price, providing a simple snapshot of income return, while Yield to Maturity (YTM) is the total annualised return assuming the bond is held until maturity and all coupons are reinvested at the same rate, making YTM a more comprehensive measure of total expected return.
The difference between current yield and YTM is fundamentally the difference between income yield and total return, and understanding this distinction is essential for fixed income portfolio construction. A bond with a face value of Rs 1,000 paying an annual coupon of Rs 80 and currently priced at Rs 900 has a current yield of 80/900 = 8.89%. Its YTM, however, accounts not just for this annual coupon income but also for the capital gain of Rs 100 (the difference between the purchase price of Rs 900 and the maturity repayment of Rs 1,000) amortised over the remaining life of the bond. YTM in this case will be higher than 8.89%, reflecting the additional return from the pull-to-par effect.
The pull-to-par concept is the mechanical driver that makes YTM differ from current yield for bonds trading away from face value. A discount bond (price below par) will have YTM greater than current yield and greater than coupon rate because the investor earns not only the coupon but also the price appreciation toward par at maturity. A premium bond (price above par) will have YTM lower than current yield because the price erosion toward par at maturity partially offsets the above-market coupon income.
In the Indian government securities market, the distinction between current yield and YTM becomes particularly visible during interest rate cycles. When the Reserve Bank of India tightened policy rates sharply in 2022-23, bond prices fell across the yield curve. For long-duration gilts such as the 10-year G-Sec, bonds that had been issued at lower coupon rates during the low-rate environment of 2020-21 traded at significant discounts to face value. Their current yields — based on their low historical coupons divided by the depressed market prices — were moderate, but their YTMs reflected the significantly higher current market rates, as the capital appreciation from below-par prices to par at maturity was factored in.
For corporate bond analysis in India, YTM is the standard metric used by institutional investors, mutual fund managers, and the bond market participants. SEBI mandates that mutual fund factsheets disclose YTM of the portfolio (portfolio YTM is the weighted average of individual security YTMs), allowing investors to assess the income-generating potential of debt fund portfolios. Current yield as a metric is more commonly used by retail investors in the fixed deposit analogy context, where the comparison is between the coupon rate and alternative savings rates rather than a comprehensive total return analysis.
One important limitation of YTM as a measure is its implicit assumption that all coupons can be reinvested at the same YTM rate. In practice, reinvestment rates fluctuate with market conditions, creating reinvestment risk. For long-duration bonds with high coupon rates, a significant portion of the total expected return is attributed to coupon reinvestment, and if reinvestment rates fall (as they tend to during economic downturns), actual realised returns will fall short of the YTM projected at purchase.