# Premium bonds vs Par bonds vs Discount bonds: Rate of return explained

Updated: Dec 02, 2020 9:06 AM

## The price of a bond and its yield are inversely related for bonds with a given principal amount, time to maturity, and coupon rate.

These days most bond issuers credit the holders’ accounts directly on every coupon payment date.

By Sunil K Parameswaran

The rate of interest paid by a bond issuer is called ‘coupon’. In the days before electronic payments, bonds would come with a booklet of coupons. Each was like a post-dated cheque. Since most bonds pay interest semi-annually, the bondholder was expected to detach the relevant coupon every six months and present it for payment.

These days most bond issuers credit the holders’ accounts directly on every coupon payment date. In 1996, I bought some RBI bonds and actually got a booklet of coupons. Today even in India, the credit takes place electronically. Even today however, bearer bonds come with a booklet of coupons. Unlike registered bonds, where a record is maintained of the ownership at all points in time, bearer bonds belong to whoever has them at a point in time. It is like a currency note. If you drop a Rs 500 note on the floor, you cannot prove that it belongs to you. The same holds true for bearer bonds. As they used to say in school, ‘finders keepers and losers weepers’.

Rate of return

The rate of return that a bond holder gets from it is called the Yield to Maturity (YTM). The price of a bond and its yield are inversely related for bonds with a given principal amount, time to maturity, and coupon rate. The logic is as follows. The issuer is going to pay pre-determined cash flows to the holders. So how can a holder extract a higher return from a given set of cash flows?

Obviously, by reducing the price that he or she pays for the bond. Thus, price and yield are inversely related. Think of coupon as the rate of return offered by the issuer. YTM, on the other hand, is the rate of return demanded by the market.

If the coupon is equal to the YTM the bond will sell for its par value, and such bonds are called par bonds. If the yield is more than the coupon the bond will be less for a price that is less than its par value, and such bonds are called discount bonds.