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Yield to Maturity

What is Yield to Maturity?

The yield to maturity of a bond is the single discount rate that, if applied to all of the bond’s cash flows, would bring the cash flows’ present value to the bond’s market price.

This is a convenient measure because the price of a bond can be unambiguously converted into its yield to maturity (and vice versa).
The overall rate of return earned by a bond after it has made all interest payments and repaid the original principle is known as YTM.

Example

In the case of a Bond, YTM is defined as the total rate of return that a Bond Holder expects to earn if a Bond is held till maturity. The YTM formula for a single Bond is:

Yield to Maturity = [Annual Interest + {(FV-Price)/Maturity}] / [(FV+Price)/2]

Consider a two-year bond with a 2.5 percent coupon that sells for USD 102. The solution is the yield y (expressed with semi-annual compounding).

$102=\frac{1.25}{1+y/2}+(\frac{1.25}{1+y/2})_{2}+(\frac{1.25}{1+y/2})_{3}+(\frac{1.25}{1+y/2})_{4}$

$102= \frac{1.25}{1+0.0074}+(\frac{1.25}{1+0.0074})_{2}+(\frac{1.25}{1+0.0074})_{3}+(\frac{1.25}{1+0.0074})_{4}$

Why is YTM important?

The most important aspect of YTM is that it allows investors to compare different securities and the profits they may expect from each. It is crucial in deciding which securities to include in their portfolios.

Owais Siddiqui
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