How to Calculate Yield to Maturity
Yield to Maturity (YTM) for a bond is the total return, interest plus capital gain, obtained from a bond held to maturity.[1] It's expressed as a percentage and tells investors what their return on investment will be if they purchase the bond and hold on to it until the bond issuer pays them back.
Steps
Calculation Help
Gathering Bond Information
- Find the purchase price of a bond. This should be easy to find because it's one of the first things that will be advertised about a bond. It's the advertised market price for the bond.
- Identify the face value of the bond. Note that the face value of a bond will be different than its purchase price. The face value is how much money you'll receive for the bond when it reaches maturity.
- The face value of a bond is often referred to as its "par value."[2]
- Find the remaining years to maturity. If the bond matures in 2020 and it's currently 2015, then there are five years (2020-2015) to maturity.
- The maturity date is when the borrower will pay you the face value of the bond.[3]
- Identify the annual interest of the bond in dollars. The bond interest rate (or coupon rate) will be expressed as a percentage (for example, 10%). You'll need to calculate the dollar amount of the annual interest by multiplying that percentage times the par value of the bond.
- For example, if the annual interest is 10% and the par value of the bond is $1,000, then the annual interest is 10% x $1,000 or $100.
Calculating Yield to Maturity
- Subtract the purchase price ($900) from par ($1000). This results in a discount of $100.
- Divide the discount ($100) by the remaining years to maturity (5) of the bond. You arrive at the annualized capital gain ($20).
- Add the annualized capital gain ($20) to the yearly interest ($50). This gives you a total annualized return of $70.
- Divide the annualized return ($70) by the purchase price ($900). This gives you the yield "A" of 7.78%.
- Subtract annualized capital gain ($20) from par ($1000). This gives you a difference of $980.
- Divide the annualized return ($70) by the result from the previous step ($980). The results is yield "B", or 7.14%.
- Average the two yields "A" and "B", or (7.78%+7.14%)/2. This results in a 7.46% yield to maturity.
Video
Tips
- When bonds are not held to maturity, current yield is the more important measure of a bond's attractiveness. When bonds are held to maturity, yield to maturity is the more important measure.
- A bond selling at discount has a yield to maturity greater than its coupon rate (capital gain at redemption contributes to the higher yield to maturity relative to coupon rate). A bond selling at a premium has a yield to maturity smaller than its coupon rate (capital loss at redemption contributes to the lower yield to maturity relative to coupon rate). A bond selling at par has yield to maturity equal to its coupon rate (no capital gain or loss at redemption).
Warnings
- Avoid buying bonds selling at a premium or even close to par if it is callable (meaning that the company issuing the bond has a right to redeem the bond at par value before its maturity). If you buy a $1000 par value bond for $1075, you could realize an immediate loss of $75 if the company decides to call the bond the next day. Bonds selling at a significant discount, on the other hand, are rarely called before maturity, because the company loses money corresponding to the bond's discount when it redeems the bond at par.
Things You'll Need
- Bond par value, or face value
- Bond coupon rate
- Bond years until maturity
- Current bond price
- Number of coupon (interest) payments per year
- Date of next coupon payment
Related wikiHows
- How to Calculate Bond Total Return
- How to Calculate After Tax Bond Yield
- How to Invest in Bonds
- How to Buy Treasury Bonds
- How to Buy Tax Free Bonds
- How to Price a Bond
- How to Invest
- How to Calculate Bond Value
Sources and Citations
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