Yield, rating and duration: three terms every bond investor meets

Yield

The coupon is the interest rate the issuer pays on the bond’s face value. The yield to maturity is the return you can expect if you buy the bond at today’s market price and hold it until it matures, assuming every payment is made on time.

When a bond trades below its face value, its yield to maturity is higher than its coupon. When it trades above face value, the yield is lower than the coupon.

Credit rating

Credit rating agencies registered with SEBI assess how likely an issuer is to pay interest and repay principal on time. Under SEBI’s standardised scale, issuers rated AAA are considered to have the highest degree of safety regarding timely servicing of debt, followed by AA and A. Lower-rated bonds usually offer higher yields to compensate for higher risk.

A rating is an opinion at a point in time, not a guarantee. Ratings can be downgraded, and a downgrade usually lowers a bond’s market price.

Duration and interest rates

Bond prices and yields move in opposite directions: if market interest rates rise, the prices of existing bonds generally fall, and if rates fall, prices generally rise.

Duration measures how sensitive a bond’s price is to those interest rate changes. The longer the duration, the larger the price movement for the same change in rates. This matters most if you may need to sell before maturity.

Reading them together

A high yield can reflect a lower credit rating, a long duration, or both. Looking at all three together gives a clearer picture of what you are being paid for and what could go wrong.