Yield to maturity (YTM)

Before you rely on it

What to check

Note the assumptions: held to maturity, no default, coupons reinvested at the same rate.

The common error

Where people go wrong with yield to maturity (YTM)

Treating it as guaranteed. Sell early, or reinvest coupons at a different rate, and the realised return departs from it.

Worked through

Yield to maturity (YTM) in plain numbers

A five-year bond pays a 5% annual coupon on $1,000 face value and trades at $950. Its current yield is $50 ÷ $950, or 5.26%; the yield to maturity also counts the $50 gain as the price climbs to $1,000 at the end. Solving for the rate that makes all the coupons and the final $1,000 worth $950 today gives about 6.2%. If the price were $1,050, the YTM would fall to about 3.9%. YTM is the single rate that ties price to cash flows, so it lets you compare bonds with different coupons and maturities; it is a promise only if held to maturity, with all payments made and reinvested at the same rate.

Easily confused

Yield to maturity (YTM) and its neighbours

YTM is not the coupon rate, current yield or yield to call; the coupon rate is the fixed payment as a share of face value. Current yield uses price but ignores the gain or loss at maturity. Yield to call assumes the bond is redeemed at the earliest call date, and yield to worst takes the lowest of the possible yields. YTM assumes the bond is held to the end. Total return over a shorter period depends on price changes and can differ widely from YTM.

In real decisions

Where yield to maturity (YTM) turns up

Bond investors use it as the standard way to compare bonds and to judge whether a price is attractive; analysts convert prices to yields to see how the market prices credit risk. Funds and indexes report an average YTM. Someone building a bond ladder compares YTMs across maturities; a calculator solves for the yield from price, coupon, face value and time to maturity, which by hand needs trial and error.

Know the edges

Where yield to maturity (YTM) stops being reliable

The assumptions of no default and reinvestment at the same rate are often unrealistic. For callable bonds YTM can overstate what you will get. Taxes, fees and inflation reduce the outcome. A high YTM can signal higher credit risk; read YTM as a yardstick, and check credit quality and call features before buying.

Quick answers

What people ask about yield to maturity (YTM)

How do I calculate YTM? It requires solving for the rate that equates the present value of all remaining payments to the price. A calculator or spreadsheet function does it by iteration.