The two measures agree only at par. Below it current yield understates the return, above it overstates it, and the gap is the gain or loss to redemption spread over the remaining years.
Current yield is the annual coupon divided by today's price; yield to maturity also counts the gain or loss to par at redemption. They are equal only at par. On two illustrative five-year bonds, a 6.00 per cent coupon at 92.00 shows a current yield of 6.52 per cent but yields 7.97 per cent to maturity, while an 8.00 per cent coupon at 106.00 shows 7.55 per cent and yields only 6.57 per cent: the bond with the higher current yield earns 1.40 points less.
Worked in full in The Credit Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Brokerage screens and fund factsheets often lead with current yield because it is easy to compute and looks like income. It answers a narrow question, how much cash the bond pays per pound or dollar invested this year, and ignores the one cash flow that never changes: the bond repays 100, not the price you paid.
| Input | Discount bond | Premium bond |
|---|---|---|
| Coupon | 6.00% | 8.00% |
| Price per 100 of face | 92.00 | 106.00 |
| Years to maturity | 5 | 5 |
| Redemption | 100.00 | 100.00 |
| Face held | 1,000,000 | 1,000,000 |
Current yield = annual coupon ÷ clean price
Yield to maturity = the rate y that solves: price = Σ (C/2) ÷ (1 + y/2)k + 100 ÷ (1 + y/2)10
Quick approximation: YTM ≈ (C + (100 − P) ÷ n) ÷ ((100 + P) ÷ 2)
In Excel: =6/92 for the current yield, and =YIELD(DATE(2026,1,1), DATE(2031,1,1), 6%, 92, 100, 2) for the yield to maturity, which returns 7.97%.
Step 1, current yield. The discount bond pays 6.00 a year on a price of 92.00: 6.52 per cent. The premium bond pays 8.00 on 106.00: 7.55 per cent. On this measure the premium bond looks 1.03 points better.
Step 2, the cash flows you actually receive. Over five years the discount bond pays 30.00 of coupons plus 100.00 at maturity, 130.00 in all, for 92.00 invested: a profit of 38.00. The premium bond pays 40.00 of coupons plus 100.00, 140.00 in all, for 106.00: a profit of 34.00. More cash, but bought with more money, and 6.00 of the price is lost at redemption.
Step 3, the pull to par. The discount bond gains 8.00 between purchase and maturity, 1.60 a year per 100 of face, or 1.74 per cent of its price. The premium bond loses 6.00, a drag of 1.20 a year, or 1.13 per cent of its price. Current yield sees neither.
Step 4, solve for the yield to maturity. Discounting all ten semiannual cash flows, the rate that returns the price is 7.97 per cent for the discount bond and 6.57 per cent for the premium bond (bond-equivalent, compounded semiannually). The approximation formula gives 7.92 and 6.60 per cent, close enough for a sense check, not for a trade ticket.
| Measure | Discount bond | Premium bond |
|---|---|---|
| Current yield | 6.52% | 7.55% |
| Pull to par a year | 1.60 | -1.20 |
| Yield to maturity | 7.97% | 6.57% |
| Price after one year, yield unchanged | 93.36 | 104.95 |
| Gap: YTM minus current yield | 1.45 pts | -0.97 pts |
On a holding of 1,000,000 face, the discount bond costs 920,000, pays 60,000 a year and redeems for 80,000 more than it cost, 16,000 a year of return that is not in the coupon. The premium bond costs 1,060,000, pays 80,000 a year and gives back 60,000 at maturity, 12,000 a year that the coupon overstates. If yields do not move, the discount bond's price drifts up from 92.00 to 93.36 in the first year and the premium bond's drifts down from 106.00 to 104.95. That drift is what current yield leaves out, earned or lost a year at a time.
The rule of thumb: below par, current yield understates the return (here by 1.45 points); above par, it overstates it (here by 0.97 points). Only a bond at par has the two equal.
| Price | Current yield | Yield to maturity | Gap, pts |
|---|---|---|---|
| 85.00 | 7.06% | 9.87% | 2.81 |
| 92.00 | 6.52% | 7.97% | 1.45 |
| 100.00 | 6.00% | 6.00% | 0.00 |
| 106.00 | 5.66% | 4.64% | -1.02 |
| 112.00 | 5.36% | 3.37% | -1.99 |
The gap widens fast with the distance from par because the pull to par is spread over a fixed number of years. Maturity works the other way: the shorter the bond, the fewer years to absorb the premium or discount.
| Years to maturity | Current yield | Yield to maturity | Gap, pts |
|---|---|---|---|
| 2 | 7.55% | 4.82% | -2.73 |
| 5 | 7.55% | 6.57% | -0.97 |
| 10 | 7.55% | 7.15% | -0.40 |
A two-year premium bond quoting a 7.55 per cent current yield actually yields 4.82 per cent. This is the case where current yield misleads most: short, high-coupon paper bought well above par, which is exactly what many income portfolios end up holding after a period of falling rates. If the bond is callable, the comparison to make is with yield to worst, which will be lower again.
A bond fund's distribution yield is close to a portfolio current yield: coupons paid out divided by NAV. A fund full of premium bonds can pay out more than it earns and erode NAV as those bonds pull to par, which is why US rules require a fund that advertises a yield to quote a standardised one built on yield to maturity; the arithmetic is in the 30-day SEC yield. When the distribution yield sits well above the SEC yield, part of each distribution is a return of capital in all but name.
Current yield is cash income per unit of price; yield to maturity is the return if held to maturity and paid. The gap between them is the pull to par, 1.60 a year on a bond at 92.00 and minus 1.20 a year on one at 106.00. The Credit Investor works yield, default, recovery and duration from the cash flows for every holding in one portfolio, and the free workbook for this case lets you rerun the comparison on any price and coupon. For the full solve, see how to calculate yield to maturity.
It depends on the price. Below par, current yield is lower than yield to maturity because it leaves out the gain to redemption: a 6.00 per cent five-year bond at 92.00 shows 6.52 per cent against 7.97 per cent. Above par it is higher, because it ignores the premium lost at maturity: at 106.00 the same coupon shows 5.66 per cent against 4.64 per cent. At par the two are equal.
Because the yield to maturity is what matters for comparison, and a premium bond can still offer a fair one. An 8.00 per cent bond at 106.00 yields 6.57 per cent; buyers accept the 6.00 of premium lost at maturity in exchange for higher coupons now. The mistake is not owning it, but judging it on its 7.55 per cent current yield.
Broadly, yes: coupons paid divided by NAV, with no allowance for premiums amortising to par. A fund holding short premium bonds can show a distribution yield well above what it earns; an 8.00 per cent two-year bond at 106.00 has a current yield of 7.55 per cent but yields 4.82 per cent to maturity. Compare the distribution yield with the SEC yield.
This article is one calculation from The Credit Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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