Bond prices in Bond Markets: How to Compare Related Measures

Bond prices in Bond Markets: How to Compare Related Measures

A bond price is the amount paid today for a defined stream of future cash flows: coupon payments, if any, and repayment of principal at maturity. It is usually quoted as a percentage of face value. A quoted price of 98 means 98% of par value, or 980 for each 1,000 of principal. The quote is not, by itself, a return measure. It is the market value assigned to the bond’s remaining contractual cash flows, given prevailing interest rates, credit conditions, liquidity and other terms.

For a conventional fixed-rate bond, price and yield move in opposite directions. When market-required yields rise, the present value of fixed coupons and principal falls; when required yields decline, it rises. This inverse relationship is central to Treasury, corporate and municipal bond markets, but its size differs markedly among bonds. A long-dated, low-coupon bond generally experiences a larger price change for a given yield move than a short-dated or high-coupon bond.

Quoted price, clean price and the cash paid at settlement

The first comparison is between the quoted, or clean, price and the dirty price paid to settle a trade. Clean price excludes accrued interest: the coupon interest earned by the seller since the previous coupon date. Dirty price equals clean price plus accrued interest. If a bond’s clean price is 101.20 and accrued interest is 0.35 points per 100 of face value, the settlement amount is 101.55 points, subject to the market’s applicable settlement conventions.

Accrued interest is not an extra investment gain created by the trade. It allocates a scheduled coupon between seller and buyer. The buyer pays the accrued amount at settlement, then receives the full next coupon if still holding the bond on the payment date. Comparing one bond’s clean price with another bond’s dirty price can therefore create a misleading impression of relative value, particularly near coupon dates.

Price also must be separated from par value and redemption value. Par, commonly 100 or 1,000 units of principal, is the reference amount used for quotes and coupon calculations. A bond can trade above par, at a premium, when its coupon is attractive relative to current market yields; it can trade below par, at a discount, when its coupon is less attractive or when investors require compensation for other risks. Unless default, a call, a put or another embedded feature changes the outcome, a plain bond repays its stated principal at maturity rather than its current trading price.

Price versus coupon, current yield and yield to maturity

The coupon rate is fixed in the bond’s terms and is calculated on face value, not on its market price. A 5% annual coupon on 1,000 of principal pays 50 a year regardless of whether the bond trades at 95, 100 or 105. It describes cash income promised by the issuer, not the return available to a purchaser at today’s price.

Current yield improves on the coupon rate by dividing annual coupon income by the bond’s current market price. It is useful as a simple income comparison, but it ignores whether the investor is likely to receive a capital gain or loss as the bond approaches maturity. A premium bond may have a coupon and current yield that exceed its yield to maturity because its price is expected to decline toward par, assuming it pays as promised. A discount bond can show the reverse pattern.

Yield to maturity incorporates the purchase price, coupon payments, principal repayment and time remaining to maturity. It is the single discount rate that equates the present value of the promised cash flows to the bond’s price. It is most useful when comparing conventional bonds with the same payment conventions and when the investor can reasonably treat the stated cash flows as the relevant outcome. It is not a guaranteed realised return: it assumes coupons can be reinvested at that yield and that the bond is held to maturity without default or a disruptive sale.

For callable corporate or municipal bonds, yield to maturity may not describe the cash flows most likely to occur, because the issuer may repay early when refinancing is advantageous. Comparisons should instead include yield to call or a yield measure based on the relevant worst-case call outcome. For municipal bonds, a stated tax-exempt yield should not be mechanically compared with a taxable Treasury or corporate yield; the investor’s tax position and the bond’s tax treatment determine whether a tax-equivalent comparison is appropriate.

Market yield, curve yield and the risks embedded in a price

A bond’s yield is not the same thing as a yield-curve point. A government yield curve is a maturity-based representation of interest rates, often estimated from prices or yields of selected instruments. Zero-coupon, or spot, rates describe discount rates for individual future dates and can be derived through a curve methodology rather than observed as the yield on one traded coupon bond. They are valuable for valuing each cash flow separately, but a bond’s quoted yield to maturity is a summary measure, not a sequence of spot rates.

To compare a Treasury with a corporate or municipal bond, start with maturity and cash-flow structure, then identify what the price is compensating investors for beyond the reference curve. The difference in yield may reflect expected credit losses, liquidity, tax treatment, call options, issue-specific demand and differences in settlement or quoting conventions. A wider yield spread does not automatically mean a bond is cheaper; it may be payment for risks that a Treasury does not carry.

Duration connects price with interest-rate risk. It estimates a bond price’s sensitivity to a small change in yield: greater duration generally means a larger percentage price move for the same rate change. Convexity refines that estimate when moves are larger. Neither measure replaces a price quote or a yield comparison. Duration addresses sensitivity to yield changes, while credit spread risk addresses changes in the compensation investors demand for issuer-specific risk. A corporate bond can decline even if Treasury yields fall when its credit spread widens.

A disciplined comparison therefore matches the measure to the question. Use clean and dirty prices to understand trade settlement; coupon and current yield for stated or near-term income; yield to maturity or call for promised cash-flow comparisons; spot curves for date-specific discounting; and duration and convexity for rate sensitivity. Check the bond’s prospectus or terms, current market quote, accrued-interest convention, yield calculation and an appropriate Treasury or swap curve before treating two quoted yields or prices as directly comparable.