Let’s say you buy a 3-year bond that pays a 3 per cent fixed coupon.
If you bought it at $97 and it matures at $100, you receive your $3 a year in coupon and approximately $1 a year in price.
That $1 comes from the $3 difference from $97 to $100, which is paid out to you over the 3 years you hold that bond.
If you put the $3 a year you’re getting from your coupon plus the $1 a year you’re getting in price, you get $4 total every year from that bond – or, about a 4 per cent yield-to-maturity.
If you bought the bond at $100 and all you get is the $3 coupon payment every year, you’d be getting a 3 per cent yield-to-maturity.
All bonds priced at $100 will have the same yield-to-maturity as their coupon, unless they have special features.
Yields are not to be confused with the yield curve, which is a graph plotting the yields-to-maturity of all kinds of Government of Canada bonds.
Yields are important because they tell you exactly what you’re earning from your bond, taking into account both the coupon payments and whether the bond matures at a different price.