Posted on: 08th Apr, 2004 12:42 am
Yield to maturity is the rate of return that measures the total performance of a bond (coupon payments and capital gain or loss) from the time of bond purchase till its maturity. It is the best measure of the return rate, since it includes all aspects of your investment.
The yield to maturity on your investment increases if you buy a bond at a lower price. This is mainly because bond prices and yields move in opposite directions. The return from a bond generally involves two kinds of payments – yield and coupon payments.
Example:
Suppose that you have purchased a bond worth $2000 with a 10% coupon and 10% yield to maturity. Then you would receive a semi-annual coupon payment equal to $100. This payment remains fixed till the bond matures after a certain period of time. But if you have applied for the yield to maturity payment, then you will receive $200 for every $2000.
Now if the market price changes, then the price of your bond will also change. Suppose that your bond is now worth $1600. It implies that then the yield to maturity will be 12.5% - that is, your yield to maturity increases with a fall in the bond price. But if the bond price increases to $2500, your yield will reduce to 8%, that is, you will be getting $200 for every $2500. The semi-annual coupon payment, however, remains similar as above.
The yield to maturity on your investment increases if you buy a bond at a lower price. This is mainly because bond prices and yields move in opposite directions. The return from a bond generally involves two kinds of payments – yield and coupon payments.
Example:
Suppose that you have purchased a bond worth $2000 with a 10% coupon and 10% yield to maturity. Then you would receive a semi-annual coupon payment equal to $100. This payment remains fixed till the bond matures after a certain period of time. But if you have applied for the yield to maturity payment, then you will receive $200 for every $2000.
Now if the market price changes, then the price of your bond will also change. Suppose that your bond is now worth $1600. It implies that then the yield to maturity will be 12.5% - that is, your yield to maturity increases with a fall in the bond price. But if the bond price increases to $2500, your yield will reduce to 8%, that is, you will be getting $200 for every $2500. The semi-annual coupon payment, however, remains similar as above.
There are three variants to yield to maturity which I would like to mention:
- Yield to Call: When a bond can be repurchased before its maturity by the issuer, the Yield to Call is also looked at by the market, the calculation is same as for the Yield to Maturity. The difference is that the cashflow is shortened on the basis of the assumption that the bond will be called.
- Yield to Put: It is similar to Yield to Call, but in YTP, the bond holder can avail the option of selling the bond on a specified date back to the issuer for a fixed price.
- Yield to Worst: In case the bond is puttable, callable or has some other features, the YTW is the lowest yield of YTM, YTC, YTP and others.