NationMaster - Encyclopedia: Yield to maturity

Yield to maturity (YTM) is the yield promised by the bondholder on the assumption that the bond will be held to maturity, that all coupon and principal payments will be made and coupon payments are reinvested at the bond's promised yield at the same rate as invested. It is a measurement of the return of the bond. This technique in theory allows investors to calculate the fair value of different financial instruments. The YTM is almost always given in terms of annual effective rate.

The calculation of YTM is identical to the calculation of internal rate of return.

This article or section does not cite its references or sources. ... Par value has several meanings depending on the context, whether used in the equities market, or in the bond markets, and partially also dependent on where in the world the par value term is used. ...

Variants of Yield to maturity

Given that many bonds have different characteristics, there are some variants of YTM:

Example

Consider a 30-year zero coupon bond with a face value of $100. If the bond is priced at a yield-to-maturity of 10%, it will cost $5.73 today (the present value of this cash flow). Over the coming 30 years, the price will advance to $100, and the annualized return will be 10%. Zero coupon bonds are bonds which do not pay periodic coupons, or so-called interest payments. ... The present value of a single or multiple future payments (known as cash flows) is the nominal amounts of money to change hands at some future date, discounted to account for the time value of money, and other factors such as investment risk. ...

But what happens in the meantime? Suppose that over the first 10 years of the holding period, interest rates decline, and the yield-to-maturity on the bond falls to 7%. With 20 years remaining to maturity, the price of the bond will be $25.84. Even though the yield-to-maturity for the remaining life of the bond is just 7%, and the yield-to-maturity bargained for when the bond was purchased was only 10%, the return earned over the first 10 years is 16.26%. This can be found by evaluating (1+i) = (25.84/5.73)^0.1 = 1.1626. An interest rate is the rental price of money. ...

Over the remaining 20 years of the bond, the annual rate earned is not 16.26%, but 7%. This can be found by evaluating (1+i) = (100/25.84)^.05 = 1.07. Over the entire 30 year holding period, the original $5.73 invested matured to $100, so 10% annually was made, irrespective of interest rate changes in between.

See

Bond valuation is the process of determining the fair price of a bond. ... The dividend yield on a company stock is the companys annual dividend payments divided by its market cap, or the dividend per share divided by the price per share. ... In economics and finance, duration is the weighted average maturity of a bonds cash flows or of any series of linked cash flows. ...

External links

Category: Fixed income analysis The bond market, also known as the debit, credit, or fixed income market, is a financial market where participants buy and sell debt securities usually in the form of bonds. ... A Corporate bond is a bond issued by a corporation, as the name suggests. ... A government bond is a bond issued by a national government denominated in the countrys own currency. ... In the United States, a municipal bond or muni is a bond issued by a state, city or other local government, or their agencies. ... A sovereign bond is a bond issued by a national government denominated in a foreign currency. ... In finance, a Fixed rate bond is a security issued by a government or a business corporation that pays a fixed amount of interest (coupon rate) on the face value (principal/par value) of the bond periodically (often every six months or annually) to the owner until a date certain... Floating rate notes (FRNs) are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a spread. ... Zero coupon bonds are bonds which do not pay periodic coupons, or so-called interest payments. ... Inflation-indexed bonds (also known as linkers) are bonds whose principal are indexed to inflation, cutting out inflation risk. ... Commercial paper is a money market security issued by large banks and corporations. ... An accrual bond is a fixed-interest bond that is issued at its face value and repaid at the end of the maturity period together with the accrued interest. ... High yield debt (non-investment grade or junk bond) is a business term referring to a corporate debt instrument, usually a bond, that has a higher yield (compared to investment grade debt) because of a high perceived credit risk (default risk). ... A convertible bond is type of bond that can be converted into shares of stock in the issuing company, usually at some pre-announced ratio. ... This article or section does not adequately cite its references or sources. ... Bond valuation is the process of determining the fair price of a bond. ... In economics and finance, duration is the weighted average maturity of a bonds cash flows or of any series of linked cash flows. ... In finance, convexity is a measure of the sensitivity of the price of a bond to changes in interest rates. ...

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