Bond Yield to Maturity

Bond Yield to Maturity

What does bond yield to maturity mean? How is it computed? The answers are forthcoming in this article.
Of the many things that you need to look out for, when making an investment in bonds, one of the prime ones is the yield that it will fetch you over the maturity period. One way of quantifying it is by calculating the bond yield to maturity percentage. This calculation is an integral part of bond research, before you decide to buy one.

Unlike stock investing, buying a bond doesn't grant you fractional ownership in any company. A bond investment is what can be classified as a 'debt security'. It is a loan that you provide a corporation or a government (in which case, it is a treasury bond), with a contract that guarantees that you will be paid a fixed interest periodically until maturity period, or paid back with principal and interest after maturity.

The maturity period may be more than one year. In most cases, the yield from bond purchase is received only after maturity. That's why, one needs to calculate bond yield to maturity, in order to gauge its potential for monetary returns. You need to check the coupon (i.e. interest rate) on the bond and the maturity period, to do the computation.

Definition

Bond yield to maturity rate is the overall rate of returns that an investor will get per year, from the payment of coupons and principal value, till the end of maturity period. In short, it is the total percentage of profits that you will receive from your investment in bonds until maturity. Hence, it is important that you calculate this value before investing. Par value is the price at which a bond will be cashed after maturity, along with interest.

Formula

Here is the required formula for calculation of the yield to maturity (YTM):

YTM (%) = [{(Bond Par Value - Purchase Value) + (Interest Earned Over Maturity Period)} ÷ {Par Value of Bond}] ÷ [Number of Maturity Years] x 100

Calculation

Say, a bond is purchased at a value of USD 900 and par value of USD 1000. The coupon rate is 5% and the maturity period is 4 years.

The interest earned, according to coupon rate of 5%, on the purchase value of USD 900 each year is USD 45. For 4 years, the total interest earned will be USD 180. Substituting all the known values in the above formula, we get:

YTM Rate = [{(USD 1000 - USD 900) + (USD 180)} ÷ USD 1000] ÷ [4] x 100 = 7%

Investing in stocks and bonds requires a lot of study and such calculations are a part of it. I hope that this example has made the calculation simple for you. Just work out some more examples to know how the formula is used.
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