Bond Yields Explained: Coupon Rates, Yield to Maturity, and Price

The Inverse Relationship That Trips Up New Investors

When the Federal Reserve raised its benchmark interest rate from near zero to 5.25–5.50% between March 2022 and July 2023, long-term Treasury bond prices collapsed. The iShares 20+ Year Treasury Bond ETF (TLT) fell more than 40% from its 2020 peak — a loss larger than many stock market corrections. Understanding why requires grasping the fundamental inverse relationship between bond prices and yields: when yields rise, prices fall, and vice versa.

The Mechanics of a Bond

A bond is a loan. The borrower (issuer) receives cash from the lender (bondholder), promises to pay periodic interest (the coupon), and repays the principal (face value) at maturity. The terminology is straightforward.

• Face value (par value) — the amount the issuer promises to repay at maturity, typically $1,000 per bond
• Coupon rate — the annual interest rate stated on the bond, expressed as a percentage of face value
• Coupon payment — the actual dollar amount paid per period (usually semiannually for U.S. bonds)
• Maturity date — when the issuer repays the face value to the bondholder
• Price — what the bond trades for in the secondary market, which fluctuates from issuance to maturity

A bond with a $1,000 face value and a 5% coupon pays $50 annually ($25 every six months). If this bond was issued when rates were 5%, it trades at par ($1,000). But if prevailing rates rise to 7%, investors can now find new bonds yielding 7%. The old 5% bond becomes less attractive, so its price must fall until its effective yield matches the new 7% market rate.

Yield to Maturity: The Complete Picture

The coupon rate is fixed at issuance. Yield to Maturity (YTM) is the total return an investor earns if the bond is held until maturity, accounting for both coupon payments and the difference between the current price and face value.

For example, if a 10-year bond with a 3% coupon and $1,000 face value now trades at $850 because rates have risen to 5%, the YTM is approximately 5%. The investor receives $30/year in coupons plus the $150 gain from buying at $850 and receiving $1,000 at maturity, spread over 10 years.

Duration: Measuring Interest Rate Sensitivity

Duration measures how sensitive a bond's price is to changes in interest rates. Technically, duration is the weighted average time to receive a bond's cash flows, expressed in years. A bond with a duration of 8 years will fall approximately 8% in price for every 1 percentage point rise in yields.

• Zero-coupon bonds have duration equal to their maturity (no interim cash flows)
• Coupon-paying bonds have duration shorter than their maturity
• Modified duration = Macaulay Duration ÷ (1 + YTM/n), gives the direct price sensitivity estimate
• The 30-year Treasury bond has duration of approximately 20 years — highly sensitive to rate changes
• A 3-month Treasury bill has near-zero duration — minimal price sensitivity

The 2022 Treasury market losses were driven by rising duration risk. Investors who held long-duration bonds expecting rates to remain low were devastated when the Fed's hiking cycle proved far steeper than markets anticipated.

The Yield Curve

The yield curve plots yields for Treasury bonds of different maturities at a single point in time. Its shape carries significant macroeconomic information.

The yield curve inverted in July 2022 when 2-year Treasury yields exceeded 10-year yields, a configuration that preceded every U.S. recession since 1970. The inversion persisted for over two years before normalizing in late 2024.

Credit Risk and Yield Spreads

Treasury bonds carry virtually no credit risk — the U.S. government can always print dollars to repay dollar-denominated obligations. Corporate bonds and municipal bonds carry varying degrees of credit risk — the possibility that the issuer defaults. To compensate, these bonds offer higher yields than comparable-maturity Treasuries.

The credit spread is the yield difference between a corporate bond and a comparable Treasury. Credit rating agencies — Moody's, Standard & Poor's, and Fitch — rate bonds on a scale from investment grade to speculative grade (high yield or junk).

• AAA/Aaa — highest quality; tiny spread over Treasuries (0.30–0.60%)
• BBB/Baa — lowest investment-grade rating; moderate spread (1–2%)
• BB/Ba and below — high-yield/junk; spreads typically 3–7% over Treasuries, widening sharply in recessions

Real vs. Nominal Yields

Nominal yields do not account for inflation. Real yield = Nominal yield − Inflation rate. Treasury Inflation-Protected Securities (TIPS) are government bonds whose principal adjusts with the Consumer Price Index, providing a guaranteed real yield. In January 2022, real 10-year TIPS yields turned negative (-1.04%), meaning investors were paying the government for inflation protection. By October 2023 they reached +2.47%, the highest level since 2009.

Types of Bonds in the Market

Beyond U.S. Treasuries, fixed income markets encompass a wide range of instruments. Government agency bonds (Fannie Mae, Freddie Mac) carry implicit government backing. Municipal bonds issued by states and cities offer interest exempt from federal income tax, making them attractive to high-income investors. Corporate bonds span the credit spectrum from AAA industrial companies to deeply distressed high-yield issuers. Mortgage-backed securities (MBS) pool home loans and pass through interest and principal payments to bondholders.

This article is for informational purposes only and does not constitute financial advice.