Bond Yield-to-Maturity

Imagine you are interested in buying a bond, at a market price that's different from the bond's par value. There are three numbers commonly used to measure the annual rate of return you are getting on your investment: Coupon Rate: Current Yield: Yield-to-Maturity: Annual payout as a percentage of the bond's par value Annual payout as a percentage of the current market price you'll actually pay Composite rate of return off all payouts, coupon and capital gain (or loss)

(The capital gain or loss is the difference between par value and the price you actually pay.) The yield-to-maturity is the best measure of the return rate, since it includes all aspects of your investment. To calculate it, we need to satisfy the same condition as with all composite payouts: Whatever r is, if you use it to calculate the present values of all payouts and then add up these present values, the sum will equal your initial investment. In an equation, 1. where c = annual coupon payment (in dollars, not a percent), Y = number of years to maturity B = par value P = purchase price c(1 + r)-1 + c(1 + r)-2 + . . . + c(1 + r)-Y + B(1 + r)-Y = P

Yield to maturity (YTM) measures the annual return an investor would receive if he or she held a particular bond until maturity. [InvestingAnswers Feature: The 9 Best Ways to Add Value to Your Home]

How It Works/Example:
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To understand YTM, one must first understand that the price of a bond is equal to the present value of its future cash flows, as shown in the following formula:

Where: P = price of the bond n = number of periods C = coupon payment r = required rate of return on this investment F = maturity value t = time period when payment is to be received .

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