Bond pricing sounds like it should be simple — you lend £1,000, you get paid back £1,000 plus interest. But bonds trade on secondary markets constantly, changing hands between investors at prices that have nothing to do with the original face value. Understanding how bonds are priced is understanding one of the most fundamental relationships in all of finance.
A bond trading at par means it's trading at its face value — exactly £1,000 for a £1,000 bond. Bonds trade at par when their coupon rate equals the current market yield for that type of bond.
A bond trading at a discount means its price is below face value — you can buy a £1,000 bond for £920. This happens when market rates are higher than the bond's coupon, making the bond less attractive relative to new issues.
A bond trading at a premium means its price is above face value — £1,080 for a £1,000 bond. This happens when market rates are lower than the bond's coupon, making it more attractive than new issues.
Current yield is the simplest measure: annual coupon ÷ current price. A £40 coupon on a £920 bond gives a current yield of 4.35%. But it ignores what happens at maturity.
Yield to maturity (YTM) is the complete measure. It accounts for the coupon payments, the difference between purchase price and face value at maturity, and the time remaining. It's the single annual return you'd earn if you held the bond to maturity and reinvested all coupons at the same rate.
YTM is higher than current yield because buying at a discount means you also gain £80 when the bond matures at £1,000. That capital gain is part of your total return.
Bonds pay coupons at fixed intervals — typically semi-annually. If you buy a bond between coupon payment dates, you owe the seller the interest that has accrued since the last payment. Bond prices are often quoted as "clean price" (excluding accrued interest) — the "dirty price" (what you actually pay) includes the accrued interest on top. This is why the actual cost of buying a bond is often slightly more than the quoted price.
Some bonds have a call provision — the issuer can redeem them early at a specified price before maturity. Companies issue callable bonds to give themselves flexibility: if rates fall, they can call in existing high-coupon bonds and reissue cheaper ones. For investors, callability is a risk — the bond gets taken away when it's performing best (low rates = high prices). Callable bonds therefore pay higher yields to compensate. Yield to call calculates the return assuming the bond is called at the earliest opportunity.
Why this matters for everyday investors: when you buy a bond ETF, you're getting exposure to many bonds at various prices, yields, and maturities. The fund's "yield" is effectively the weighted average YTM of everything it holds. Understanding YTM helps you interpret what a bond fund's quoted yield actually means — and why a high yield isn't automatically better if it comes with higher credit or interest rate risk.
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