What is ‘Yield To Maturity (YTM)’
Yield to maturity (YTM) is the total return anticipated on a bond if the bond is held until the end of its lifetime. Yield to maturity is considered a long-term bond yield, but is expressed as an annual rate. In other words, it is the internal rate of return of an investment in a bond if the investor holds the bond until maturity and if all payments are made as scheduled.
Explaining ‘Yield To Maturity (YTM)’
Calculations of yield to maturity assume that all coupon payments are reinvested at the same rate as the bond’s current yield, and take into account the bond’s current market price, par value, coupon interest rate and term to maturity. YTM is a complex but accurate calculation of a bond’s return that can help investors compare bonds with different maturities and coupons.
Example: Calculating Yield to Maturity Through Trial-and-Error
Imagine that you currently hold a bond whose par value is $100. Also suppose that the bond is currently priced at $95.92, so it has a current yield of 5.21%, and also that the bond matures in 30 months and pays a semi-annual coupon of 5%. To calculate YTM here, you would begin by determining what the cash flows are. Every six months you would receive a coupon payment of $2.50 (0.05 x 0.5 x $100). In total, you would receive five payments of $2.50, in addition to the future value of $100. Next, we incorporate this data into the formula, which would look like this:
Uses of Yield to Maturity (YTM)
Yield to maturity can be quite useful for estimating whether or not buying a bond is a good investment. An investor will often determine a required yield, or the return on a bond that will make the bond worthwhile, which may vary from investor to investor. Once an investor has determined the YTM of a bond he or she is considering buying, the investor can compare the YTM with the required yield to determine if the bond is a good buy.
Variations of Yield to Maturity (YTM)
Yield to maturity has a few common variations that are important to know before doing research on the subject.
Limitations of Yield to Maturity (YTM)
Like any calculation that attempts to determine whether or not an investment is a good idea, yield to maturity comes with a few important limitations that any investor seeking to use it would do well to consider.
Further Reading
- Yield to maturity is always received as promised – mpra.ub.uni-muenchen.de [PDF]
- Yield to Maturity Is Always Received as Promised: A Reply – mpra.ub.uni-muenchen.de [PDF]
- Computing realized compound yield with a financial calculator: A note – www.clutejournals.com [PDF]
- The Quadratic Approximation to the Yield to Maturity – www.jstor.org [PDF]
- Some results on bond yield and default probability – www.jstor.org [PDF]
- Analysis of the Effect of Corporate Governance on Yield to Maturity Through Bond Rating in Indonesian Financial Institution – www.atlantis-press.com [PDF]
