Bond Yield and Yield to Maturity

October 4, 2012 in Bond

Bond yield is nothing but the return on bond investment. So suppose we buy the bond at the time of issue at a issue price or face value of 100 USD and the annual interest offered on the bond is 10% then our annual return or annual coupon value would be USD 10. The current yield on that bond would be the coupon value divided by the face value i.e. 10/100 = 10%. Hence on a new bond the current yield is equal to the interest rate returns on that bond.

Bond Yield

The Bond Yield formula is as follows:

Yield on Bonds = (Coupon Value) ÷ (Face Value).
Bond - Yield to MaturityNow what happens if the market price of that bond changes. Let’s say that the inflation has gone up and hence the benchmark interest rates also. As we have seen above the market price of your bond would go down. Let’s say that the market price has gone down to 90 from the original 100. The point to be noted that even if the market price has gone down but the coupon value would remain same.

So now the current yield on that same bond = 10/90 = 11.11%. If I buy the bond at USD 90, my returns are better than the original yield of 10%. But is it enough to make my decision about the bond purchase?

No, it is not. What I would like to see is what would be total returns against the investment on that bond, assuming that I buy today and keep that bond till the maturity period.

Bond – “Yield to Maturity”:

Yield to Maturity (YTM) is nothing but the total returns on a bond if we keep the bonds till their maturity period.

Suppose the bond has 4 years remaining till it’s maturity date then the simplest formula for yield to maturity would be as follows:
Yield to maturity = Coupon value for 1st year + Coupon value for 2nd year + Coupon value for 3rd year + Coupon value for 4th year + The face value of the bond when we redeem it.

We will not go into the mathematical formula because the above example is the very simple yield to maturity. There may be different kinds of bonds i.e. Zero Coupon Bonds and all and the calculation would differ. Also in the above example we have take full 4 years but it could be 3 and half years or 7 years 2 months, just for example. What we wanted to cover is the concept of yield to maturity and hope that it is clear now.

Further resources:

1) What are Bonds?
2) Types of Bonds
3) Bond Terminology
4) Bond and Inflation
5) Bond Risks
6) Investment in Bonds

2 responses to Bond Yield and Yield to Maturity

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  2. The interest rate on your bonds will stay solid as long as that is the type of bond you pheaucsrd. Some bonds have step rates or zero coupon rates. However, it sounds like you are buying a regular bond that has a fixed percent with a fixed term. Each day, the market price of the bond fluctuates based on its selling and buying values. As long as you hold it to maturity, none of this matters. The only down side for a bond these days is the solvency of the company. Like Lehman Bros. Their bond holders just received a notice that they will get $600 from a $5K investment. Bonds are a fab investment right now. Best investment is a mid term bond that would be held for five years. You can get some good ones out there with a term of five years with a 7 plus percentage return. Anything over five years, plan to hold them for a while. Eventually interest rates will go up and if you need to sell your bond, you may not get the full value.