2.3 Current Yield and Yield to Maturity

Three rates you must never mix up

Fixed-income questions on the UCP exam repeatedly use three related but different numbers:

If you remember only one sentence: coupon is on face; current yield is coupon on price; YTM is the full life return including price-to-par.

Current yield — definition and peso examples

Current yield = annual coupon payment ÷ current market price.

It answers: “If I buy at today’s price, what percentage coupon income do I receive per year?” It does not answer: “What total return will I earn if I hold to maturity?”

Example A — Par bond

• Face: PHP 100,000
• Annual coupon: PHP 6,000 (coupon rate 6%)
• Market price: PHP 100,000
• Current yield = 6,000 / 100,000 = 6.00%
• Same as the coupon rate when price = face.

Example B — Discount bond

• Face: PHP 100,000
• Annual coupon: PHP 6,000 (coupon rate still 6% on face)
• Market price: PHP 90,000
• Current yield = 6,000 / 90,000 = 6.67% (approximately)

Current yield rose because the denominator (price) fell. The investor still receives only PHP 6,000 of coupon cash, but paid less for that income stream.

Example C — Premium bond

• Face: PHP 100,000
• Annual coupon: PHP 6,000
• Market price: PHP 110,000
• Current yield = 6,000 / 110,000 = 5.45% (approximately)

Current yield fell below the 6% coupon rate because the buyer paid more than face for the same PHP 6,000 coupon.

Yield to maturity — conceptual definition

Yield to maturity is the constant annualized yield that makes the present value of all remaining coupon payments plus repayment of face equal to the bond’s current dirty/full economic price (conceptually). Solving YTM precisely needs a financial calculator or spreadsheet IRR/YTM function; the UCP expects relationships and ranking, not long manual IRR iterations.

Intuition:

• Buy a discount bond → you also expect a capital gain as price moves toward face → YTM is higher than current yield (extra return beyond coupons).
• Buy a premium bond → you expect a capital loss toward face → YTM is lower than current yield (part of the rich coupon is given back via principal).
• Buy at par → no built-in capital gain or loss to maturity from price vs face → YTM ≈ current yield ≈ coupon rate (before finer compounding conventions).

Ordering rules (high-value memory set)

For option-free fixed-rate bonds priced off a flat yield assumption:

Discount bond
YTM > current yield > coupon rate

Premium bond
Coupon rate > current yield > YTM

Par bond
YTM = current yield = coupon rate (approximately / by definition in stylized questions)

These orderings are classic exam material. If a question gives two of the three rates, you can often infer premium vs discount.

Linking YTM to par / premium / discount

This matches Section 2.2: market yield above coupon forces price below face; market yield below coupon forces price above face. YTM is the market’s yield measure for that bond’s remaining life at the observed price.

Worked ranking example (PHP)

Bond D:

• Face PHP 100,000; coupon rate 5% → annual coupon PHP 5,000
• Price PHP 92,000
• Current yield = 5,000 / 92,000 ≈ 5.43%
• Because price < face, YTM must be greater than 5.43% (say the calculated YTM is about 6.2% in a multi-year example).
• Ordering: YTM 6.2% > current yield 5.43% > coupon 5% → discount, consistent.

Bond P:

• Face PHP 100,000; coupon 8% → PHP 8,000
• Price PHP 112,000
• Current yield = 8,000 / 112,000 ≈ 7.14%
• YTM will be below 7.14% and below 8% (capital loss to par).
• Ordering: coupon 8% > current yield 7.14% > YTM → premium.

Inverse relationship still rules YTM

YTM and price are two sides of the same coin:

• Price up → YTM down
• Price down → YTM up

If BSP policy tightening lifts required yields, existing bond prices fall and their YTMs rise toward the new market. Fixed-income UITFs show lower market values (NAVPU pressure) while the yields available on the revalued portfolio are higher for new money—cold comfort to a client who must redeem now.

Current yield vs YTM: client conversations

Suitability and sales-integrity angles for Module 1 / later sales modules:

1. Do not sell “current yield” as total return. A premium bond’s current yield still looks decent while YTM is lower once pull-to-par is included.
2. Do not sell “YTM” as a guaranteed rate. YTM assumes holding to maturity, reinvestment at the YTM, and timely cash flows. UITF participants redeem units at NAVPU, not by locking a single bond’s YTM.
3. Money-market vs bond funds. Short instruments have less price volatility; long bond funds can show large interim NAVPU moves even if the portfolio’s average YTM looks attractive on a fact sheet.
4. Disclosures. Risk Disclosure Statements and product materials should not imply principal protection when market yields can reprice the portfolio.

Other yield terms (recognition level)

If a bond is callable and trading at a premium, yield-to-call may be more conservative than YTM because the issuer has incentive to call expensive coupons. Straight non-callable government bonds are the cleanest UCP teaching cases.

Exam traps for this section

1. Using face instead of price in current yield — current yield denominator is market price, not face (unless at par).
2. Calling current yield “YTM” — current yield ignores the built-in capital gain/loss to face.
3. Wrong premium/discount ordering — remember discount: YTM highest; premium: coupon highest.
4. Thinking higher YTM means the bond price went up — higher YTM accompanies lower price.
5. Promising YTM to UITF clients as locked-in return — unit holders get NAVPU performance, not a bond-by-bond locked YTM.

Mini decision tree for MCQs

1. Are they asking income only on today’s price? → Current yield = coupon ÷ price.
2. Are they asking total return if held to maturity at this price? → YTM.
3. Do they give coupon vs YTM? → Infer par / premium / discount.
4. Did rates rise? → Prices down, YTMs on outstanding bonds up.

Master these four steps and most Module 1 yield questions become mechanical.