Yield to Maturity (YTM)
Yield to maturity is the total return anticipated on a bond if held until it matures, accounting for all coupon payments, the difference between purchase price and par value, and the time value of money.
Exam Tip
YTM = TOTAL return. Discount bond: CY < CY < YTM. Premium bond: CY > CY > YTM. Most complete yield measure!
What is Yield to Maturity?
Yield to Maturity (YTM) is the most comprehensive measure of a bond's return. It calculates the total return you would receive if you bought a bond today and held it until maturity, assuming all coupon payments are reinvested at the same rate.
YTM Components
| Component | What It Includes |
|---|---|
| Coupon Payments | All interest payments over bond's life |
| Capital Gain/Loss | Difference between purchase price and par value |
| Time Value | When payments are received |
| Reinvestment | Assumes coupons reinvested at YTM rate |
YTM vs. Other Yield Measures
| Yield Type | What It Measures | Formula |
|---|---|---|
| Coupon (Nominal) Yield | Stated rate on bond | Annual Coupon ÷ Par Value |
| Current Yield | Income relative to price | Annual Coupon ÷ Market Price |
| Yield to Maturity | Total return if held | Complex IRR calculation |
| Yield to Call | Return if called early | YTM calculation to call date |
YTM and Bond Prices
| Bond Price | YTM vs. Coupon Rate |
|---|---|
| Discount (below par) | YTM > Coupon Rate |
| Par (at $1,000) | YTM = Coupon Rate |
| Premium (above par) | YTM < Coupon Rate |
Yield Relationships (Important!)
Bond Bought at Discount:
Coupon Yield < Current Yield < YTM
Bond Bought at Premium:
Coupon Yield > Current Yield > YTM
Bond Bought at Par:
Coupon Yield = Current Yield = YTM
Simplified YTM Formula (Approximation)
YTM ≈ (Annual Coupon + (Par - Price) ÷ Years) ÷ ((Par + Price) ÷ 2)
Example Calculation
Bond Details:
- Par Value: $1,000
- Coupon Rate: 6% ($60/year)
- Current Price: $950
- Years to Maturity: 5
Approximate YTM:
- Annual gain to par: ($1,000 - $950) ÷ 5 = $10
- Total annual return: $60 + $10 = $70
- Average investment: ($1,000 + $950) ÷ 2 = $975
- Approximate YTM: $70 ÷ $975 = 7.18%
Factors Affecting YTM
| Factor | Effect on YTM |
|---|---|
| Interest Rate Changes | Rates up → YTM up, Price down |
| Time to Maturity | Longer = more sensitive to rates |
| Credit Quality | Lower quality = higher YTM required |
| Callable Features | May limit upside (consider YTC) |
YTM Limitations
| Limitation | Reality |
|---|---|
| Reinvestment Assumption | May not reinvest at same rate |
| Hold to Maturity | Many investors sell before maturity |
| Call Risk | Bond may be called early |
| Default Risk | Assumes no default |
Yield to Call (YTC)
For callable bonds, also calculate YTC:
- Uses call date instead of maturity
- Uses call price instead of par
- Investor earns lower of YTM or YTC
Study This Term In
Related Terms
Yield
SecuritiesYield is the income return on an investment, expressed as a percentage, including interest or dividends received.
Current Yield
SecuritiesCurrent yield is a bond's annual interest payment divided by its current market price, expressing the income return as a percentage without accounting for capital gains or losses.
Bond
SecuritiesA bond is a fixed-income debt security where the issuer owes the holder a debt and pays interest (coupon) plus principal at maturity.
Duration
SecuritiesDuration is a measure of a bond's price sensitivity to interest rate changes, expressed in years. A higher duration means greater price volatility when interest rates change.