# Relationship Between Bond Price & Yield to Maturity

This statement represents the easiest way to remember the relationship between bond prices and yield to maturity: "When bond prices go up, bond yields go down and vice versa." OK, that’s all well and good, but why does it happen that way? To answer that, we need to understand how bond prices and interest rates work.

## What Is a Bond?

In its most basic form, a bond acts as a debt instrument. It’s kind of like an IOU or a pledge to repay. When a company issues bonds (or a city, state, municipality etc.) that company basically says, if you buy our bonds (loan us money) we promise to pay you interest (coupon rate) over the life of the bond and when the full payment is due (maturity date) we will pay you back the original investment. When you purchase a bond, you buy it at one of three price points: at par, at a premium or at a discount. A bond bought at par means the coupon rate equals the current interest rate. A bond bought at a premium means the coupon rate is higher than the existing interest rate and a discounted bond means the coupon rate is lower than the existing interest rate. Bonds pay coupon payments semiannually. For example, a two-year \$1,000 bond with a 5 percent coupon would pay you two payments of \$25 the first year, one \$25 payment the first part of the second year and one final payment of \$1,025 the second half of the second year.

## Par Value

Think of par value as par in golf. You made the hole in the required amount of strokes, not too many and not too few. The price you pay for a bond centers on its par value of 100 because when the bond matures you receive 100 percent of its value.

## Yield to Maturity

Yield to maturity, sometimes called YTM, really refers to the anticipated rate of return of a bond if you hold it until it matures and if you reinvest all of your coupon payments at a fixed interest rate. This represents the return you receive from your entire investment, not just your initial bond investment.