What is a Bond’s Yield to Maturity (YTM)
Yield to Maturity is the basis on which bond market trades. Whenever, you sell or buy bonds, three things are taken into consideration: maturity date, bond’s credit quality and the coupon interest rate. When you look into all of these three things, you will be able to determine the yield to maturity of what is required by marketplace and what determines the dollar price of your bond. Remember that bonds are debt securities which are distributed by corporations and governments. In addition to this, bonds are marketable securities and its market value alters with the change in the credit quality and the changing interest rates.
Instructions
-
1
Yield to Maturity (YTM)
Bond’s yield to maturity is the rate of return when the bond is bought at its market price and held until maturity. It reflects the discount rate which is equal to discounted value of future cash flows of bond to its current market price. Its calculation involves par value, current market price, coupon interest rate and time to maturity. -
2
Formulae
In this equation,
- B0 = the bond price
- C = the annual coupon payment
- F = the face value of the bond
- YTM = the yield to maturity on the bond
- t = the number of years remaining until maturity
-
3
Coupon interest
The bond’s coupon interest let you know how much interest you will earn by a particular bond over a year. In case you have bought a bond with a 9 per cent coupon. Regardless of you buying the bond at a premium or at discount, you will get $90 annually over the bond until the bond matures. -
4
Credit quality
The bond market needs more yield with bonds with low credit e.g. BAA in comparison for bonds with high credit rating such as AAA or AA. In case your 9 per cent bond has AAA credit rating, it will cost you 1100. On the other hand if your 9 per cent bond has BAA credit rating, it will cost you $920. -
5
Maturity date
Yield demanded by market of a bond is higher if the maturity time is longer. There is a high risk if a bond matures in 30 years i.e. the company can shut down. This is why it yields more.
