Yield to maturity

A bond carries two rates and they answer different questions. The coupon is what the issuer agreed to pay on the day the bond was sold, fixed for life as a percentage of face value. The yield to maturity is the internal rate of return of buying at today's market price, collecting every remaining coupon and receiving 100 at maturity. The first is a record of the past. The second is what the market charges this borrower now, which is why only the second belongs in a cost of debt.

Because the coupon cannot move, the price does all the adjusting, and that is the whole reason price and yield run in opposite directions. A bond bought below par earns its coupon plus the gain back to 100, so its yield sits above the coupon. A bond bought above par earns its coupon less the fall back to 100, so its yield sits below it. The difference between the two is the pull to par, spread across the remaining life.

Sitting between them is the current yield, coupon divided by price, which counts the income and ignores the pull to par entirely. It is a fair income measure for a holder and a poor measure of return, and mistaking one for the other is a common way to misread a discount bond.

Two limits are worth carrying. The calculation assumes the bond runs to maturity, which is not the investor's decision on callable paper, so the number to underwrite there is the yield to worst. And it is a promised yield rather than an expected one, because it assumes every payment arrives in full. On a bond trading at a deep discount precisely because the market doubts repayment, the promised yield can be twenty per cent or more while no lender expects to earn it, which is why feeding a distressed yield into a WACC as the cost of debt overstates the rate badly.