1. The three key metrics
When evaluating a bond, you'll see three different "return" numbers. Each means something different:
| Metric | Formula | What it tells you |
|---|---|---|
| Current yield | Annual coupon ÷ Current price | Income yield today |
| YTM | IRR of all future cash flows | Annualised return if held to maturity |
| Total return | (Coupons + Price change) ÷ Invested | Actual rupee gain over holding period |
Current yield ignores price changes and time. YTM is the correct metric for comparing bonds. Total return shows your actual rupee gain.
2. Why YTM differs from coupon rate
The coupon rate is fixed on the face value. But YTM depends on the price you pay:
- Price = Face value: YTM = Coupon rate (par bond)
- Price > Face value: YTM < Coupon rate (premium bond)
- Price < Face value: YTM > Coupon rate (discount bond)
💡 Example: A bond with 7% coupon bought at ₹1,050 (face value ₹1,000) has a current yield of 6.67% and a YTM lower than 7% because you'll lose ₹50 at maturity.
3. How to calculate YTM
YTM solves for the rate that makes the present value of all future cash flows equal to the current price:
Price = Σ [Coupon ÷ (1 + YTM)t] + [Face Value ÷ (1 + YTM)n]
This calculator solves YTM using the Newton-Raphson method — the same iterative approach used by Excel's YIELD function.
4. A worked example
Buy 100 bonds at ₹1,050 each. Face value ₹1,000, coupon 7.5%, maturity 5 years.
- Total invested: ₹1,05,000
- Annual coupon income: ₹7,500
- Total coupons over 5 years: ₹37,500
- Capital loss at maturity: −₹5,000
- Pre-tax total return: ₹32,500 (30.95%)
- YTM: ~6.30% (lower than 7.5% coupon due to premium)
- Current yield: 7.14%
- Post-tax return (30% slab, 10% LTCG): ~₹22,250 (21.19%)
- Post-tax YTM: ~4.15%
Notice how the premium purchase reduces YTM to 6.30% from the 7.5% coupon rate. And taxes reduce it further to 4.15%. Always evaluate post-tax YTM for income investing.
5. Types of bonds in India
| Bond type | Coupon | Tax on coupons | Tax on gains |
|---|---|---|---|
| Govt Securities (G-Secs) | 7%–7.5% | Slab rate | 10% LTCG |
| Corporate Bonds (listed) | 7%–9% | Slab rate | 10% LTCG |
| Tax-Free Bonds | 5%–6.5% | Tax-free | 10% LTCG |
| Sovereign Gold Bonds | 2.5% | Slab rate | Tax-free on redemption |
| RBI Floating Rate Savings | 8.05% | Slab rate | N/A (7-year lock-in) |
Tax-free bonds may have lower coupons but higher post-tax returns for high-slab investors. Sovereign Gold Bonds are unique — the capital gain at redemption is fully tax-free.
6. When to buy bonds
Bonds are best for:
- Regular income: Coupon payments provide predictable cash flow.
- Capital preservation: High-quality bonds return your principal at maturity.
- Portfolio ballast: Bonds reduce equity volatility in a mixed portfolio.
- Rate-cut cycles: Bond prices rise when interest rates fall — capital gains opportunity.
Avoid long-duration bonds if you expect interest rates to rise — their prices will fall. Match bond duration to your investment horizon.
7. Common mistakes to avoid
- Comparing coupon rates. YTM is the right metric — coupon can mislead, especially with premium or discount bonds.
- Ignoring the reinvestment risk. YTM assumes coupons are reinvested at the same rate. If rates fall, actual return is lower.
- Ignoring taxes. Coupon income is taxed at slab. Post-tax YTM may be 2%–3% lower than pre-tax.
- Chasing high yields. High-yield bonds carry higher credit risk. Check the credit rating.
- Buying and holding long bonds blindly. Duration risk matters if rates change.
- Ignoring liquidity. Illiquid bonds may be hard to sell before maturity without a discount.
8. Final thoughts
Bond returns are best evaluated on a post-tax YTM basis, not on coupon alone. Premium and discount purchases significantly affect your actual return, and taxes reduce it further.
Use this calculator to see YTM, current yield, total return, and post-tax returns for any bond. Then compare with other fixed-income options before investing.
