## Calculating the Real Return of Your Bonds: Beyond the Coupon You See

When evaluating where to invest your money in fixed income, the advertised coupon is only half the story. The true yield depends on another factor that most ignore: the price at which you buy the bond. This is where the **YTM formula** —or Yield to Maturity— comes into play, a metric that shows you the actual return you will get.

### Why is the YTM different from the promised coupon?

Imagine two bonds: one pays an 8% coupon but is purchased at an inflated price (107 €), another pays 5% but is bought cheaply (94 €). Which one do you choose just by looking at the coupon? Most would pick the first. But with the **YTM formula**, you would discover that the second actually offers a higher real return.

This happens because the YTM captures two sources of profitability simultaneously:

**Periodic coupons.** These are the payments you receive annually, semiannually, or quarterly. They can be fixed, variable, or even nonexistent (in zero-coupon bonds).

**Gain or loss at maturity.** When the bond matures, you always get back the nominal (100 €). If you bought it at 94 €, you gain 6 €. If you bought it at 107 €, you lose 7 €. That difference, amortized over the years you hold the asset, dramatically adjusts your true profitability.

### How a regular bond works in practice

A typical bond lasts a defined number of years. You pay its purchase price today, receive periodic coupons until maturity, and at that time, recover your nominal plus the final coupon. During the bond’s life, its market price fluctuates due to changes in interest rates and the issuer’s credit quality.

If you buy on the secondary market, you can acquire it in three different ways:

**At par:** you pay exactly its nominal value (1,000 € for a 1,000 € nominal bond).

**Below par:** you pay less than the nominal (pay 975 € for a 1,000 € bond), which boosts your return.

**Above par:** you pay more than the nominal (pay 1,086 € for a 1,000 € bond), which reduces your actual profitability.

### Applying the YTM formula: a practical example

Suppose you find a bond trading at **94.5 €**, with an **annual 6% coupon** and **4 years** until maturity. Its **YTM formula** would be:

*YTM = (Cash flows discounted to present value = Price paid)*

Solving this equation yields: **YTM = 7.62%**

Note that the YTM (7.62%) exceeds the coupon (6%) thanks to that favorable purchase price below par.

Now, the same bond but trading at **107.5 €**:

*Applying the same YTM formula:*

Result: **YTM = 3.93%**

Here, the inflated price compresses the return. What looked like an 6% annual yield actually becomes just 3.93% once you include the loss you'll suffer at maturity.

### YTM vs. TIN vs. TAE: don’t confuse the terms

It’s critical to differentiate these metrics because each tells you something different:

**YTM (Internal Rate of Return).** Measures the actual profitability of a bond considering both coupons and price variations. It’s the most accurate metric for comparing bonds in the secondary market.

**TIN (Nominal Interest Rate).** Simply the agreed-upon interest rate without additional costs. It’s the pure interest figure but incomplete for decision-making.

**TAE (Annual Equivalent Rate).** Adds hidden expenses like commissions, insurance, and other costs to the TIN. It’s what regulators like the Bank of Spain recommend using to compare financing offers.

**Technical Interest.** Used in insurance, includes costs such as life insurance embedded in the product.

### What factors modify your YTM

Even if you don’t perform the exact mathematical calculation, it’s useful to intuit how YTM moves:

**Higher coupon = higher YTM.** A more generous coupon amplifies your total return.

**Lower coupon = lower YTM.** Fewer periodic payments compress the yield.

**Buying below par = boosted YTM.** That initial discount adds to your return.

**Buying above par = penalized YTM.** That premium reduces your net gain.

**Special features.** Convertible bonds vary with the underlying stock price. Inflation-linked bonds adjust according to this economic measure.

### Why is YTM your decisive tool in fixed income

The **YTM formula** allows you to compare target investments. If you find bond A with a YTM of 3.67% and bond B with 4.22%, you instantly know which one is superior, regardless of what coupon they promote.

This is especially useful when coupons are misleading. A bond with an advertised 8% coupon might have a disappointing YTM of 3.67% if bought at a high price. Another with a 5% coupon could surprise you with a 4.22% YTM if well valued.

### Final warning: YTM isn’t everything

Although YTM is your best profitability indicator, never ignore the credit quality of the issuer. During the Greek crisis, Greek sovereign bonds traded with YTM exceeding 19%. That was not an opportunity; it was a trap: the country was on the brink of default.

Only the intervention of the European Central Bank prevented Greece from declaring insolvency and canceling those bonds. An astronomical YTM often signals disproportionate risk, not a bargain.

Therefore: rely on YTM, but always cross-check with the issuer’s solvency and political stability. The YTM formula is your compass, but risk analysis is your map.