Flat Yield vs Redemption Yield: Bond Yields for the CISI Exam
Flat yield versus redemption yield, explained for the CISI exam: the formula, a worked example, and the premium and discount relationship candidates always muddle.
What is the difference between flat yield and redemption yield?
The flat yield counts only the coupon income relative to price: flat yield = (annual coupon ÷ market price) × 100. The redemption yield, also called the gross redemption yield or yield to maturity, folds in the capital gain or loss from holding the bond to maturity, so it reflects the total return. At a premium the redemption yield sits below the flat yield, which sits below the coupon rate. At a discount that order flips, and at par all three are equal.
- Flat yield formula
- Flat yield = (annual coupon ÷ market price) × 100
- Other names for flat yield
- Running yield or current yield
- Worked example
- Nominal £100, coupon 5%, price £125. Cash coupon is £5, so the flat yield is (5 ÷ 125) × 100 = 4%
- Redemption yield
- Also called the gross redemption yield or yield to maturity. The total annual return if you hold the bond to redemption, including the capital gain or loss
- Trading at a premium
- Price above nominal, so a capital loss to maturity. Redemption yield is below the flat yield, which is below the coupon rate
- Trading at a discount
- Price below nominal, so a capital gain to maturity. Coupon rate is below the flat yield, which is below the redemption yield
- Trading at par
- No capital gain or loss, so coupon rate, flat yield and redemption yield are all equal
- Most common mistake
- Calculating the coupon off the market price instead of the nominal value, which is usually £100
Bond yields are the calculation candidates dread most, and they should not. The flat yield is a one-line sum. The redemption yield you mostly need to understand rather than compute. And the relationship between the two, which is where the exam earns its marks, follows one simple rule once you see it. Here is the whole thing.
Flat yield: the one you calculate
The flat yield, also called the running yield or current yield, is the annual coupon as a percentage of the bond's current market price.
Flat yield = (annual coupon ÷ market price) × 100
The coupon is a percentage of the bond's nominal (face) value, usually £100, so work out the cash coupon first, then divide by the price you actually pay.
Worked example. A bond has a nominal value of £100, a coupon of 5%, and trades at £125. The cash coupon is 5% of £100 = £5. The flat yield is (5 ÷ 125) × 100 = 4%. Notice the flat yield (4%) is below the coupon rate (5%), because the bond is trading above its nominal value. Hold that thought, because it is the key to the whole topic.
Redemption yield: the one you understand
The flat yield ignores something important: if you hold the bond to maturity, you get the nominal value back, which may be more or less than you paid. The redemption yield, or gross redemption yield, also called the yield to maturity, folds that capital gain or loss into the return alongside the coupon. It is the total annual return if you hold the bond to redemption.
For the foundation paper you generally need to understand what the redemption yield captures and how it compares to the flat yield, rather than compute it by hand, since the full calculation is involved. What you must get right is the comparison.
Test yourself on CMP: Securities
4 questions written to the current syllabus, in the format of the real paper. Pick an answer and the explanation appears. Nothing to sign up for.
A general insurer expects its claims to fall due within months. Which holding BEST matches those liabilities?
Not quite. The answer is B.
Short liabilities of uncertain timing need assets whose capital value is stable and which can be sold at once, so bills, deposits and short gilts dominate a general fund. Long index-linked gilts suit a life fund or pension scheme paying decades ahead. Property let to institutions and private equity sold to a trade buyer both take months to realise and would leave the insurer unable to meet a sudden run of claims.
A bond's coupon rate is below the return that investors currently require from it. How will the bond be priced in the market?
Not quite. The answer is C.
If the fixed coupon is less than the required return, the only way the bond can offer buyers that return is for its price to fall below par, so that the shortfall in income is made up by a capital gain to redemption. A premium arises in the opposite case, when the coupon exceeds the required return; pricing at par requires the two rates to be equal; and the original issue price has no bearing on where it trades now.
Which charge does a UK investor pay on buying shares on the London Stock Exchange but NOT on selling them?
Not quite. The answer is A.
Stamp duty reserve tax is charged at 0.5% on purchases of UK shares and falls on the buyer alone, which is why the cost of a round trip is asymmetric. Commission is charged by the broker on both sides of a bargain. The panel levy the broker passes on is a flat charge on every bargain above the threshold, and it falls on purchases and sales alike. Value added tax is not charged on dealing commission on shares.
Who arranges the meetings with institutions held in four cities in the fortnight before a new corporate bond is priced?
Not quite. The answer is C.
The roadshow is organised by the lead manager, which selects the investors to be seen, books the meetings and briefs the borrower's management. The closest distractor is the issuer, whose executives present at the meetings but who rely on the lead manager to arrange them. The rating agency assesses credit quality separately and the trustee acts for holders only after the bonds are in issue.
That is 4 of more than 10,800 questions in the PasskeyPrep bank. Chapter 1 of every exam is free, with the study notes and flashcards that go with it, and every answer is marked and explained the way these were.
The rule that ties them together
Here is the relationship the exam loves to test. It hinges on whether the bond trades above or below its nominal value.
Trading at a premium (price above nominal)
You paid more than £100 and you only get £100 back, so there is a capital loss to maturity. That drags the total return down. The order is: redemption yield is below the flat yield, which is below the coupon rate. In our example: coupon 5%, flat yield 4%, and the redemption yield lower still.
Trading at a discount (price below nominal)
You paid less than £100 and you get £100 back, so there is a capital gain to maturity, which lifts the total return. The order flips: coupon rate is below the flat yield, which is below the redemption yield.
Trading at par (price equals nominal)
No capital gain or loss, so all three are equal: coupon, flat yield and redemption yield are the same.
Learn that as a single picture. Premium drags returns down so redemption yield is lowest; discount lifts them so redemption yield is highest; at par everything lines up. Get that and you can answer the comparison questions without touching a calculator.
Where people slip
The first trap is computing the coupon off the price instead of the nominal value. The coupon is always a percentage of nominal, usually £100, not of what you paid. Cash coupon first, then divide by price.
The second is muddling the order at a premium versus a discount. Do not memorise two lists; understand the one idea behind both. A capital loss to maturity pulls the redemption yield below the flat yield; a capital gain pushes it above. The direction follows from whether you overpaid or underpaid relative to what you get back.
Drill it for free. Try a set of free CISI practice questions, calculations included, or take the free Introduction diagnostic to review a short sample of Intro topics.
Bonds are not the only calculation the CISI tests. Equities have the dividend yield, and both feature in the Securities exam and the Introduction to Securities & Investment.
Frequently asked questions
How do you calculate the flat yield on a bond?
Flat yield = (annual coupon ÷ market price) × 100. Work out the cash coupon as a percentage of the nominal value first, usually £100, then divide by the current market price.
What is the difference between flat yield and redemption yield?
The flat yield counts only the coupon income relative to price. The redemption yield (yield to maturity) also includes the capital gain or loss you make from holding the bond to maturity, so it reflects the total return.
Why is the flat yield lower than the coupon when a bond trades at a premium?
Because you are paying more than the nominal value to receive the same fixed coupon. Dividing a fixed coupon by a higher price gives a lower yield. At a discount the opposite happens and the flat yield exceeds the coupon.
Which is higher, flat yield or redemption yield?
It depends on the price. At a premium the redemption yield is below the flat yield; at a discount it is above; at par they are equal, along with the coupon rate.