What is Yield to Maturity?

Yield to Maturity refers to the expected returns an investor anticipates after keeping the bond
intact till the maturity date. Unlike the current yield, which measures the present value of the
bond, the yield to maturity measures the value of the bond at the end of its bond term. In
other words, a bond’s expected returns after making all the payments on time throughout the
life of a bond.
YTM considers the effective yield of the bond, which is based on compounding.

calculating the actual YTM will require trial and error by considering different rates in the
current value of the bond until the price matches the actual market price of the bond.

AYTM: -

The below formula focuses on calculating the approximate yield to maturity,

Where,

 C is the Coupon.
 F is the Face Value of the bond.
 P is the current market price.
 n will be the years to maturity.

The formula below calculates the bond’s present value. If you have the bond’s present value,
you can calculate the yield to maturity (r) in reverse using iterations.

Present Value of Bond = [C / (1+r )] + [C / ( 1+r )^2] . . . . . . [C / ( 1+r )^ t ] + [F / ( 1+r )^ t ]

Example #1
Approximate yield to maturity.AYTM

Coupons on the bond  80.

AYTM = (80 + (1000 – 94) / 12 ) / ((1000 + 940) / 2)

AYTM –8.76

Example #2

The government of the India now wants to issue a 20 year fixed semi-annually paying bond
for their project. The price of the bond is Rs. 1,101.79, and the face value of the bond is
$1,000. The coupon rate is 7.5% on the bond. Based on this information, you are required to
calculate the approximate yield to maturity on the bond.

Solution:

Use the below-given data for the calculation of yield to maturity.

Coupon on the bond will be $1,000 * 7.5% / 2 which is $37.50, since this pays semi-
annually.

AYTM = ( 37.50 + (1000 – 1101.79) / (20 * 2) )/ ((1000 + 1101.79) / 2)

This is an approximate yield on maturity, which shall be 3.33%, which is semiannual.

Annual YTM will be –

Example #3
Mr. Rollins has received the lump sum amount from the lottery. He is a risk-averse person
and believes in low risk and high return. He approaches a financial advisor, and the advisor
tells him he is the wrong myth of low risk and high returns. Then Mr. Rollins accepts that he
doesn’t like risk, and a low-risk investment with a low return will do. The advisor gives him
two investment options, and the details of them are below:
Both coupons are paid semi-annually. Mr. Rollins Now is perplexed about which bond to
select. He asks the Advisor to invest in option two as the price of the bond is less, and he is
ready to sacrifice a 0.50% coupon. However, the Advisor tells him instead to invest in option
1.
You are required to validate the advice made by the advisor.
Solution:

Option 1

Coupon on the bond will be $1,000 * 9% / 2 which is $45, since this pays semi-annually.

Yield to Maturity (Approx) = (45 + (1000 – 1010) / (10 * 2)) / (( 1000 +1010 )/2)

YTM will be –This is an approximate yield on maturity, which shall be 4.43%, which is
semiannual.

Annual YTM will be –

Therefore, the annual Yield on maturity shall be 4.43% * 2, which shall be 8.86%.

Option 2 Coupon on the bond will be $1,000 * 8.50% / 2 which is $42.5, since this pays
semi-annually.

Yield to Maturity (Approx) = (42.50 + (1000 – 988) /(10 * 2))/ (( 1000 +988 )/2)
This is an approximate yield on maturity, which shall be 4.34%, which is semiannual.

Annual Yield to Maturity will be –

Therefore, the annual Yield on maturity shall be 4.34% * 2, which shall be 8.67%.

Since the YTM is higher in option 2; hence the advisor is correct in recommending investing
in option 2 for Mr. Rollins.

Relevance and Uses

 Yield to maturity allows an investor to compare the bond’s present value with other
investment options in the market.
 TVM (Time value of money) is taken into consideration while calculating YTM,
which helps in better analysis of the investment about a future return.
 It promotes making credible decisions as to whether investing in the bond will fetch
good returns compared to the value of the investment at the current state..

Yield to Maturity (YTM) Summary

A bond's yield to maturity (YTM) is the internal rate of return required for the present value
of all the future cash flows of the bond (face value and coupon payments) to equal the
current bond price. YTM assumes that all coupon payments are reinvested at a yield equal to
the YTM and that the bond is held to maturity.

What Is a Bond’s Yield to Maturity (YTM)?

The YTM of a bond is essentially the internal rate of return (IRR) associated with buying
that bond and holding it until its maturity date. In other words, it is the return on investment
associated with buying the bond and reinvesting its coupon payments at a constant interest
rate. All else being equal, the YTM of a bond will be higher if the price paid for the bond is
lower, and vice-versa.