Yield to Maturity is measured as a long-standing bond return stated as an annual rate. Its takes into consideration the bond’s present market value, average value, coupon rate and period of maturity. It is the interest rate a stakeholder receives on spending every single coupon payment from the bond at continuous interest rate till the bond’s maturity time. The present-day assessment of all of the prospect money inflow makes it equal to the bond’s market value.
In a layman’s language, it’s nothing but the rate of return of an investment that is held till its maturity time.
Let’s understand some of the important terms connected with Yield to Maturity in details.
Coupon Rate – It’s the yearly income as a fraction of the bond’s average value
Current Yield – It’s the yearly income as a fraction of the present market value one actually pays
Yield-to-Maturity– It’s the compound rate of return off all payments, coupon and capital profit or loss
How is it beneficial?
Yield to maturity thinks through present value of a bond’s future coupon payments. It talks about the time value of money, which a current yield calculation doesn’t.
How is it calculated?
Most bonds pay coupons on a fixed plan normally four times a year, two times a year, or once a year. Therefore, its coupon payment turns in to a kind of annuity, whose current price can be easily calculated. In real, bonds giving coupons pay them as per a static plan, which allows depositors to evaluate Yield to Maturity with the help of an annuity table.
It’s very simple to calculate Yield to Maturity when fixed value, present value, coupon rate and the number of periods are given.
Let’s find the coupon payment first which we need to calculate Yield to Maturity.
Coupon Payment = Fixed Value * Coupon Rate
Yield to Maturity = (Coupon Payment + (Fixed Value – Present Value)/n)/ (Fixed Value +2 Present Value)/3
Is there any exception to the above calculation?
As some bonds have dissimilar features, there are some variations of Yield to Maturity. These are:
Yield to Call – when a bond can be purchased back by the issuer before the maturity date, the bazaar considers “Yield to call”. Its calculation is same as of Yield to Maturity, but assuming that the bond will be purchased back, the cash flow is reduced.
Yield to Put – It’s same as yield to call, when the bond holder has the choice to sell the bond back to the issuer at a fixed price on a stated date.
Yield to Worst: when a bond can be purchased back by the issuer before the maturity date or when the bond holder has the choice to sell the bond back to the issuer at a fixed price on a stated or has supplementary features; the yield to worst is the lowermost yield of yield to maturity, yield to call, yield to put, and others.