A bond’s yield to maturity ratio is one of the benchmarks for determining the value of a bond to an investor. It is one way of calculating your potential returns from investing in the bond. Unless you are buying a newly-issued bond, it is likely that you have bought the bond for a price either higher or lower than its par value. Likewise, you are not likely to hold on to the bond until it matures—you can sell it before its maturity date for one reason or another. Therefore, your rate of return on the instrument will not likely by the coupon rate or the annual interest rate on the face value of the bond.
- You can expect a higher yield if you have purchased a bond at discounted price. For example, if a bond has a face value of $2,000 and it pays $200 in interest, your yield will be 10%. However, if you bought the bond for $1,800, your yield is effectively 11%.
- Conversely, if you purchased a bond for a higher price than face value, your yield is lower than the coupon rate. For instance, if you purchased a $2,000 bond for $2,200, and its interest per year is $200, your yield will be 9.1%.
- The YTM ratio measures the bond’s yield from your day of purchase until its maturity date, during which you can redeem the face value plus the yield.
- The YTM is also a function of time. It takes into factor the time you hold on to the bond before selling it.
A bond YTM can be computed with the following formula:
c(1 + r)-1 + c(1 + r)-2 + . . . + c(1 + r)-Y + B(1 + r)-Y = P
- C is the annual coupon payment
- Y represents the number of years before the bond matures
- B is the bond’s face value
- P is the purchase price.
Most financial advisers will, of course, use a business calculator to simply plug in some figures and get the yield figure. You can try accessing a yield calculator online at money-zine.com. The calculator will ask for the following information:
- Current bond price
- Par value
- Coupon rate in percentage
- Years to maturity
Once you click “Calculate,” the website gives you the results for current bond yield and the YTM.
Other notable YTM calculators include investopedia.com, moneychimp.com and quantwolf.com .
A bond’s yield is usually quite complicated for an end-user or investor to compute. Brokers and financial advisors usually make use of a financial calculator when looking for a bond’s yield to maturity. If you are in doubt, consult with your broker or financial advisor. These professionals can help you arrive at the bigger picture, by providing information on yield to maturity with respect to your portfolio.
Note that funds based on bonds will not have a YTM, because these are made of bonds of different rate and term. Therefore, you will have a current yield, but not a YTM. Also, investors and brokers usually talk about YTM when they mention “yield.” However, your rate of return on a bond will usually be arrived at through different means.