What You Earn vs. What You’re Paid: Understanding Yield, Coupons, and Bond Prices

Jenna Koenings is a fixed income portfolio manager at Northwestern Mutual Wealth Management Company.

Understanding bonds starts with a few core concepts: coupon, yield, premium, discount, and par. Together, these terms help explain what income a bond pays, how its price changes over time, and what an investor ultimately earns. The coupon represents the bond’s stated interest payment, while the yield reflects the return based on the price paid. As market conditions change, a bond may trade above or below its face value before moving back toward par at maturity. The definitions and examples below walk through how price, yield, and income work together in practice.

Key definitions:

Coupon: the interest payment a bond pays each year, often split between two semiannual payments—in other words, the income you receive.

Yield: a calculation of return based on a bond’s current price, interest payments, and the amount repaid at maturity. In this article, yield generally refers to yield to maturity or yield to worst, depending on the bond’s features.

Par: the face value of a bond and what you will be repaid at maturity. This can also mean that the bond’s current price is 100.

Premium: when a bond’s price is above 100. You pay more than what the bond will repay at maturity.

Discount: when a bond’s price is below 100. You pay less than what the bond will repay at maturity.

The de minimis rule: Guidelines that dictate how the IRS taxes a bond bought on the secondary market at a discount. While this rule applies to all bond types, the de minimis rule comes into play in particular when it comes to municipal bonds because of how they are taxed, which we’ll dive deeper into below.

For any bond, the de minimis threshold, or the minimum discount level at which a bond’s gain may be taxed less favorably, is calculated as 0.25% x Face Value x Years to Maturity.

Let’s go through an example using a municipal bond to see how all these terms relate to each other.

Example: Assume you own a state bond with a $10,000 par value and a 5 percent coupon.

• Every year you are scheduled to receive $500 of interest split between two semiannual installments.
• The yield and price on this bond will change relative to the external environment and your time to maturity throughout the remainder of the life of the bond.
• The table below illustrates what the price of the bond would be in various yield environments. The scheduled income does not change as long as the bond is held to maturity and the issuer fulfills its payment obligations.

Answering investors’ top fixed income questions

Let’s go over some frequently asked questions from investors when it comes to bonds.

1. Why would you buy bonds at a premium?

Paying more for a bond than it will repay at maturity can feel counterintuitive, but it becomes clearer when you focus on the relationship between yield and coupon. Setting aside credit considerations, when market yields fall below a bond’s coupon, that bond will trade at a premium. Over time, the price will amortize back toward par as it approaches maturity. Investors are willing to pay this premium because the bond offers higher income than is currently available in the market, providing additional cash flow to reinvest. The total return, or yield, reflects not just this higher income but also the gradual decline in price toward par. It incorporates the bond’s current price, coupon payments, and time to maturity.

2. When do you buy bonds at par?

As you can see from the table above, a bond generally trades at par when its coupon rate is in line with the market yield required for a bond with similar maturity, credit quality, and features.

Municipal bonds often trade above par because investors may be willing to pay more upfront for the bond’s income stream and tax advantages. Investors in this space are willing to pay a higher upfront price (the premium) to receive higher tax-free income over the life of the bond. Higher-coupon municipal bonds may be less likely than lower-coupon bonds to trade deeply below par, which can help reduce certain tax (see de minimis rule in next section) and liquidity concerns if rates rise.

Other fixed income bonds, such as corporate bonds or Treasury bonds, may be issued with coupons closer to market yield at the time of issue. This does not prevent the price and yield movements throughout the life of the bond, though. Bond prices may move between premium, par, and discount over time as interest rates and other market factors change.

Let’s look at an example. The below chart reflects the price movement of a 30-year 4.375 percent coupon Treasury issued on February 15, 2008. The solid horizontal line represents par. You can see the instances when corresponding market rates exceeded 4.375 percent and the price of the bond moved below par.

3. When does a bond fall into the de minimis threshold?

A bond is trading at a discount when the price falls below 100. This means that the coupon of the bond is lower than market yields. The price of the bond will accrete toward par as it moves closer to its maturity. For municipal bonds, the de minimis rule particularly should be considered.

As discussed, the de minimis is something to pay particular attention to when investing in municipal bonds. Municipal bonds are generally federally tax-exempt, but any price appreciation toward par of a bond that was purchased at a discount can be considered a taxable event. This is why it is important for municipal bond buyers to pay attention to the de minimis rule once a bond’s price falls below its face value. If a bond is purchased at a discount that is smaller than the de minimis threshold, the market discount generally is not treated as ordinary income under the rule. If the discount is large enough to exceed the threshold, some or all of the gain attributable to that discount may be taxed as ordinary income when the bond is sold or matures. This matters because it can reduce the bond’s after-tax return. Sometimes, bond prices quickly drop past this threshold, reflecting the fact that the buyer may owe ordinary income taxes. While these bonds may appear to offer higher yields compared to premium bonds, after-tax returns may be more similar once the tax treatment is considered.

By keeping these concepts in mind—especially the difference between income (coupon) and return (yield)—you’ll be better equipped to evaluate bonds in any market environment. As prices and yields shift, understanding these relationships helps ensure you’re making decisions aligned with your income needs and overall investment goals.