How Bonds Generate Returns

Coupon payments and price changes

5 min read

Where does my return come from?

Two Sources of Return

Bond returns come from two sources: coupon payments and price changes. Understanding both is essential for evaluating bond investments.

1. Coupon Payments (Interest Income)

Fixed periodic payments based on the bond's coupon rate
Typically paid annually (Germany) or semi-annually (US)
Calculated as: Face Value × Coupon Rate
Example: €1,000 face value × 2.5% coupon = €25/year

2. Price Changes (Capital Gains/Losses)

Bonds trade at prices above (premium) or below (discount) face value
If you sell before maturity, your return depends on the market price
Bond prices move inversely to interest rates (explained in Chapter 3)

Total Return = Coupon Income + Price Change

The Face Value Principle

At maturity, you receive the face value (Nennwert/nominal value), typically €1,000. During the bond's life, market price can differ significantly from face value.

Price Impact on Returns

Buying at discount (price < 100) increases your return
Buying at premium (price > 100) reduces your return

GERMAN EXAMPLE

A Bundesanleihe with 2.5% coupon, purchased at 98% of face value, held to maturity: • Annual coupon: €25 per €1,000 nominal • Capital gain at maturity: €20 (bought at €980, repaid at €1,000) • Total return exceeds the stated coupon rate

KEY TAKEAWAY

Your return is not just the coupon. The price you pay relative to face value matters just as much.