Chapter 1 1.3

Understanding Yield (YTM)

What bond yields represent, how to interpret them, and why they matter for traders and investors

What is “Yield”?

You've all heard the term yield curve, but before we begin explaining what that is, it's essential to understand what "yield" means. In the bond market, yield is the all-in rate of return an investor earns on a bond.

When professionals say "yield," they are almost always referring to Yield-to-Maturity (YTM). This is the single most important metric for comparing bonds.

Types of Yield

While YTM is the gold standard, it's helpful to understand why other yield measures fall short. The key distinction is which portions of the bond's cash flows (as seen from section 1.2) each measure accounts for:

  1. Coupon Yield (or Nominal Yield)
    • What it is: The fixed interest rate stated on the bond, paid by the issuer.
    • Example: A 10-year JGB with a 1.5% coupon has a coupon yield of 1.5%.
    • What it accounts for: Only the annual coupon payments.
    • What it ignores: The price you actually paid for the bond and the principal repayment at maturity.
    • Why it's incomplete: If you buy a bond at ¥95 (below par), you'll receive the 1.5% coupon payments plus a ¥5 capital gain when it matures at ¥100. Coupon yield ignores this gain entirely.
  2. Current Yield
    • What it is: The annual coupon payment divided by the bond's current market price.
    • Formula: $$\text{Current Yield} = \left(\frac{\text{Annual Coupon Payment}}{\text{Market Price}}\right) \times 100$$
    • What it accounts for: Annual income relative to the price you paid.
    • What it ignores: The capital gain or loss when the bond matures back to par (¥100).
    • Why it's incomplete: If you buy that same bond at ¥95, current yield tells you about the income stream, but it doesn't account for the fact that you'll receive ¥100 at maturity—a ¥5 gain on your ¥95 investment.
  3. Yield-to-Maturity (YTM)
    • What it is: The total annualized return you will earn if you buy a bond at its current market price and hold it until it matures.
    • What it accounts for: The entire cash flow stream:
      1. All future coupon payments you will receive.
      2. The principal repayment at maturity (¥100 per unit).
      3. Any capital gain or loss (the difference between your purchase price and par value).
      4. The time value of money (it properly discounts all future cash flows).
    • Why it's superior: YTM is the only measure that values the complete picture—both the income component (coupons) and the return of principal component—using a single consistent rate. This makes it the true "internal rate of return" on your bond investment.

For all JGBs and in all professional market discussions, "yield" means Yield-to-Maturity (YTM).

How is YTM Calculated?

You cannot calculate YTM with simple arithmetic. It is the single rate (denoted as $r$) that makes the present value of all future cash flows equal to the bond's current market price.

Important: YTM compounds (re-invests) semi-annually (every 6 months), matching when JGBs actually pay coupons.

References

  1. Japan Ministry of Finance. "JGB Interest Rate Data." Available at: https://www.mof.go.jp/english/policy/jgbs/reference/interest_rate/index.htm.