What is the yield to maturity?

The yield to maturity is a figure that is used for the valuation of bonds. The yield to maturity shows, which yield a investor gets, when he buys a bond at the market price, collects all interest payments and gets paid back at 100% at maturity.   

   

Calculate the yield to maturity

(yield to maturity (ytm) formula, to calculate the yield of a bond)

The yield to maturity can easily and relatively accurate be calculated with this formula:

   

                                    nominal - market-price               
YTM =    interest+     remaining time to maturity in years    
                                      (nominal + market-price) 
                                                            2



Example

A bond is trading at 97.3%. The interest is 4.60% per year. The bond is due in 4.19 years.

Whats the yield to maturity?

step 1:    nominal 100 - market-price 97.3 = 2.7
step 2:    2.7 / remaining life 4.19 = 0.64
step 3:    interest 4.6 + 0.64 = 5.24
step 4:    (nominal 100 + market-price 97.3)/2  = 98.65
step 5:    5.24 / 98.65 = 0.0531

answer:   the yield to maturity is 0.0531. That's 5.31%

   

Use of the yield to maturity:

With the yield to maturity different bonds can be compared. Which bond yields better? A 5-year bond, trading at 101% with 4% coupon, or a 4-year bond, trading at 99% with 3% coupon?

answer: the 5-year bond has a yield to maturity of 3.78%, the 4-year bond is at 3.27%. The investor can gain transparency with the ytm and will rather buy the 5-year bond with a higher yield.