Nominal Yield

Key takeaways

• Nominal yield (also called coupon yield) is the annual interest payment divided by a bond’s face (par) value.
• It is a fixed percentage set at issuance and does not change if the bond’s market price changes.
• Nominal yield is influenced primarily by expected inflation and the issuer’s credit risk.
• Nominal yield differs from current yield because current yield is based on the bond’s market price, not its par value.

What is nominal yield?

Nominal yield is the coupon rate a bond issuer promises to pay bondholders, expressed as a percentage of the bond’s par (face) value. It remains fixed for the life of the bond and is often called the nominal rate or coupon yield.

How to calculate nominal yield

Formula:
* Nominal yield = Annual interest payment ÷ Par value

Example:
* A bond with a $1,000 par value that pays $50 annually has a nominal yield of 50/1000 = 5%.

Nominal yield vs. current yield

Nominal yield is based on par value, while current yield uses the price an investor actually paid. If the purchase price differs from par, the actual return will differ from the nominal yield:
* Bought at par ($1,000): nominal yield = current yield = 5% (50/1000).
* Bought at a premium ($1,050): nominal yield = 5%, current yield = 50/1050 ≈ 4.76%.
* Bought at a discount ($950): nominal yield = 5%, current yield = 50/950 ≈ 5.26%.

Bonds with high coupon rates that are callable are often redeemed early by issuers, because they represent a higher liability relative to lower-coupon bonds.

What determines nominal yield?

Two main components determine the nominal yield set at issuance:
1. Expected inflation
2. Credit risk of the issuer

Inflation

Nominal rates typically reflect the expected inflation rate plus a real interest rate. When inflation expectations rise, issuers set higher coupon rates to compensate investors. For example, short-term Treasury yields were very high during periods of elevated inflation historically, and much lower when inflation expectations were low.

Credit risk (and credit spread)

Government securities are generally treated as nearly risk-free, so corporate bonds usually carry higher nominal yields to compensate for default risk. Credit rating agencies assess issuer creditworthiness; lower-rated issuers pay higher coupon rates. The difference in yields between bonds with similar maturities but different credit quality is the credit spread. Higher nominal yields imply greater default risk for the investor.

Summary

Nominal yield is the fixed coupon rate based on a bond’s face value. It is set at issuance and reflects inflation expectations and the issuer’s creditworthiness. Because it is tied to par value, nominal yield may differ from the actual return an investor receives when buying a bond at a premium or discount.