The value of a bond is obtained by discounting the bond's expected cash flows to the present using an appropriate discount rate. Yield to maturity is the discount rate at which the sum of all future cash flows from the bond is equal to the price of the bond. "Time to maturity" refers to the length of time before the par value of a bond must be returned to the bondholder. This section will show you how to calculate a bond's yield to maturity and calculate the price of a bond.
Yield to maturity is the discount rate at which the sum of all future cash flows from the bond are equal to the price of the bond.
Classify a bond based on its market value and Yield to Maturity
Differentiate between yield to call, yield to put, and yield to worst
To name the current price, notably of a financial security.
IRR. The rate of return on an investment which causes the net present value of all future cash flows to be zero.
the additional cost paid by the issuer for the right to buy back the bond at a predetermined price at a certain time in the future
The Yield to maturity (YTM) or redemption yield of a bond or other fixed-interest security, such as gilts, is the internal rate of return (IRR, overall interest rate) earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity, and that all coupon and principal payments will be made on schedule.
Contrary to
popular belief, including concepts often cited in advanced financial
literature, Yield to maturity does not depend upon a reinvestment of
dividends. Yield to maturity, rather, is simply the discount
rate at which the sum of all future cash flows from the bond (coupons and principal) is equal to the price of the bond. The formula for yield to maturity:
Yield to maturity (YTM) = [(Face value / Present value)^{1/Time period}]-1
The YTM is often given in terms of Annual Percentage Rate (A.P.R.), but usually market convention is followed: in a number of major markets the convention is to quote yields semi-annually (for example, an annual effective yield of 10.25% would be quoted as 5.00%, because 1.05 x 1.05 = 1.1025).
If the yield to maturity for a bond is less than the bond's coupon rate, then the (clean) market value of the bond is greater than the par value (and vice versa).
As some bonds have different characteristics, there are some variants of YTM:
For instance, you buy ABC Company bond which matures in 1 year and has a 5% interest rate (coupon) and has a par value of $100. You pay $90 for the bond. The current yield is 5.56% ((5/90)*100). If you hold the bond until maturity, ABC Company will pay you $5 as interest and $100 par value for the matured bond. Now for your $90 investment, you get $105, so your yield to maturity is 16.67% [= (105/90)-1] or [=(105-90)/90].