Yield to Maturity

Definition

Yield to Maturity (YTM) is the total return expected on a bond if the bond is held until its maturity date. It represents the discount rate that makes the present value of all future coupon payments and the final principal repayment equal to the current market price of the bond. YTM is a key metric used by investors to evaluate the attractiveness and potential returns of fixed-income securities.

5 Must Know Facts For Your Next Test

1. Yield to Maturity accounts for both the coupon payments and the final principal repayment when calculating the total return on a bond.
2. YTM is calculated using the bond's current market price, coupon rate, and time to maturity, assuming the bond is held until it matures.
3. A higher YTM indicates a higher expected return for the investor, but also generally implies higher risk.
4. YTM can be used to compare the relative attractiveness of different bonds, as it provides a standardized metric for evaluating potential returns.
5. YTM is an important consideration for investors when constructing fixed-income portfolios and making decisions about bond investments.

Review Questions

• Explain how Yield to Maturity (YTM) is calculated and what factors it takes into account.
  • Yield to Maturity (YTM) is calculated using the bond's current market price, coupon rate, and time to maturity. It represents the discount rate that makes the present value of all future coupon payments and the final principal repayment equal to the current market price of the bond. YTM accounts for both the periodic coupon payments and the final principal repayment when determining the total expected return on a bond, assuming the bond is held until its maturity date.
• Describe the relationship between Yield to Maturity and the risk of a bond investment.
  • Generally, a higher Yield to Maturity (YTM) indicates a higher expected return for the investor, but also implies higher risk. Bonds with higher YTMs typically have lower credit ratings, longer maturities, or other characteristics that make them riskier investments. Conversely, bonds with lower YTMs are often considered safer, more stable investments, but may offer lower potential returns. Investors must weigh the trade-off between risk and return when evaluating bond investments based on their YTM.
• Explain how Yield to Maturity can be used to compare the attractiveness of different bond investments within a household's financial capital portfolio.
  • Yield to Maturity (YTM) provides a standardized metric that allows investors to compare the potential returns of different bond investments. By calculating and comparing the YTM of various bonds, households can evaluate the relative attractiveness of fixed-income securities and make informed decisions about how to allocate their financial capital. YTM can help households identify bonds that offer the best combination of risk and return, aligning with their investment objectives and risk tolerance as they seek to supply financial capital through bond investments.

Related terms

Coupon Rate: The fixed annual interest rate paid on a bond, expressed as a percentage of the bond's face value.

Bond Price: The current market value of a bond, which fluctuates based on factors such as interest rates, credit risk, and time to maturity.

Maturity Date: The date on which the bond issuer must repay the principal amount of the bond to the bondholder.