Interest Rate vs. Yield to Maturity (YTM)

From time to time we receive questions regarding how bond interest (or interest rate) is different from yield and yield to maturity, YTM, and which one is the ‘real’ number for investors.

In bond offerings, you can find several words that all seemingly indicate one of the most important factors for investors - return or, you could say, earnings from your investment. The usual terms are: rate of interest (liet. palūkanos), coupon (liet. kuponas), yield (liet. pajamingumas) and yield to maturity (YTM) (liet. pajamingumas iki išpirkimo). To make matters more confusing, all these terms could be the same number or different numbers, depending on other bonds’ terms.

In most cases, you will find the terms ‘rate of interest’ and ‘coupon’, that are equal in their meaning and indicate the straight-forward sum of money that you will receive in return for your investment. For example, you are buying 10 bonds for € 1 000 nominal value and a 9% annual rate of interest (or coupon). Effectively, you will receive € 900 annually for the term of the bonds.

However, in some cases in the bond terms you might find both ‘rate of interest’ (or ‘coupon’) and ‘yield’ listed side-by-side, and the percentages may be different, for example, 10% and 12%. What does it mean and which number indicates the ‘real return’ for you as an investor?

These type differences can be found in the situations of distributions of larger bond programs with different stages (‘tranches’) over time, as well as bonds with a distribution price different from the nominal value of the bonds, to increase their yield to create better ‘value’ for investors.

Larger-scale bond issues are ‘tranched’ by adapting them accordingly to the cash-flow needs of the borrowing project/company (issuer) over time. This practice is usually used in the development of large commercial real estate projects, when all funds are not needed immediately. We have covered these type of issues in our previous newsletters, but effectively, the issuer has to adjust the price of the new tranche for the new investors coming in into the larger bond programme. In such cases the issuer can either make sure that both tranche 1 and tranche 2 investors receive the same return, or could alterate the price of the bond to create a higher / lower return for the new incoming investors.

Under the normal market circumstances, the later tranches in a development project should offer less return, as the project becomes less risky over a period of time (development nears completion). However, in the current market circumstances, when the base rates were rising dramatically, the effect was different – the investors who came in later in the project received higher returns. An example of this could be Marijas 2 SIA project, where the initial investors who came in into the bond programme in March 2022 received 6.5% interest, whereas the latest investors coming into the 9th tranche in January 2024 will receive 9% yield (return).

Another example that we used previously can be the bonds of Kreda group last year, when the second stage of the bonds issued with a 10% coupon/interest was distributed by a financial brokerage company at a lower nominal price of € 1 000 for 959,1118, thus creating a 12% yield (return) for investors. In this case, investors will receive a fixed interest rate of 10% during the servicing of the bonds, and at the time of maturity the bonds will be redeemed at a nominal price of € 1 000, thereby obtaining an additional 2% annual return that was generated during the period of the bonds.

Yield to maturity (YTD) is usually used to describe the yield that investors will receive until the bonds are repaid back, i.e. when they reach maturity. During the initial bonds offer usually it is the same as the ‘yield’, however if a bond is traded, it can be used to determine whether the bond is being traded a discount. Further, if the bond issue has an early redemption option, yield to call (YTC) term is used in order to illustrate the bonds return that investors will receive if the bonds are repaid back ahead of the maturity.

Although the explanation above is quite simplistic, we hope that it is useful for the initial assessment and understanding of the return that you, as an investor could expect from a particular bond issue.