The interest rate, or "coupon" rate, of a fixed-rate bond indicates the amount of
interest payable on a bond calculated as a percentage of the bond's principal amount.
Thus, a $10,000 fixed-rate bond paying interest at 5% would pay $500 in interest
each year, usually payable in equal $250 semi-annual payments. This amount does
not change, regardless of the price at which the bond may be sold in a trade.
Yield, on the other hand, takes into account the price at which the bond was purchased
in calculating the total potential earnings on an investment in the bond. In the
example above, if the price of a trade in that security were 100% (that is, the
purchase price of a $10,000 bond is $10,000), then the yield would be 5%, the same
as the interest rate. If, however, the bond was traded at a discount (for example,
at a price of 99%, or $9,900), the yield would be higher than 5%. The higher yield
reflects the fact that, in addition to receiving the 5% interest rate, a customer
who retains the bond until maturity or earlier redemption will also receive the
$100 difference between the purchase price and the principal amount. If the bond
was traded at a premium (for example, at a price of 100.5%, or $10,050), the yield
would be lower than 5%. In this case, the lower yield reflects the fact that, although
the purchaser will receive the 5% interest rate, he or she will receive $50 less
at maturity or earlier redemption than was paid for the bond at the time of purchase.
Price and yield are said to vary inversely.