What is Yield to Maturity (YTM)?
Yield to Maturity is the total return you'll earn on a bond if you hold it until it matures and reinvest all coupon payments at the same rate. It's the most comprehensive measure of a bond's return, accounting for:
- Current market price – what you pay today
- Face value – what you receive at maturity
- Coupon payments – periodic interest income
- Time to maturity – how long until the bond expires
Why YTM Matters
YTM lets you compare bonds with different coupons, prices, and maturities on an equal footing. A bond with a 3% coupon trading at a discount might actually have a higher YTM than a 5% coupon bond trading at a premium.
YTM Formula (Approximation)
YTM vs Current Yield vs Coupon Rate
These three terms are often confused, but they measure different things:
| Metric | What It Measures | Formula |
|---|---|---|
| Coupon Rate | Annual interest as % of face value | Coupon ÷ Face Value |
| Current Yield | Annual interest as % of market price | Coupon ÷ Market Price |
| Yield to Maturity | Total annualized return if held to maturity | Includes price gain/loss + coupons |
Quick Comparison Rule
Discount bond: YTM > Current Yield > Coupon Rate
Premium bond: Coupon Rate > Current Yield > YTM
Par bond: YTM = Current Yield = Coupon Rate
Bond Pricing: Premium vs Discount vs Par
A bond's price relative to its face value tells you a lot about market conditions:
Trading at a Discount (Price < Face Value)
When a bond's coupon rate is lower than current market rates, investors demand a lower price to compensate. The discount provides extra return at maturity, boosting YTM above the coupon rate.
Trading at a Premium (Price > Face Value)
When a bond's coupon rate exceeds market rates, investors pay extra for the higher income. The premium reduces total return since you receive less than you paid at maturity.
Trading at Par (Price = Face Value)
When the coupon rate equals market rates, the bond trades at face value. YTM, current yield, and coupon rate are all equal.
Interest Rates and Bond Prices
The inverse relationship between interest rates and bond prices is fundamental to fixed income investing:
The Golden Rule
When interest rates rise, bond prices fall. When interest rates fall, bond prices rise. This is because existing bonds must adjust their prices to offer competitive yields compared to newly issued bonds.
Duration Risk
Longer-maturity bonds are more sensitive to interest rate changes. A 30-year bond will drop more in price than a 5-year bond when rates rise by the same amount. This sensitivity is measured by "duration."
How to Use YTM in Investment Decisions
1. Compare Bond Investments
Use YTM to compare bonds with different characteristics. A corporate bond yielding 6% YTM vs. a Treasury at 4.5% YTM—is the extra 1.5% worth the credit risk?
2. Assess Interest Rate Risk
If you expect rates to rise, consider shorter-duration bonds with lower YTM sensitivity. If rates will fall, longer bonds will appreciate more.
3. Plan Your Cash Flows
YTM helps estimate total returns. If you need a specific return for a financial goal, YTM tells you whether a bond meets your requirements.
4. Evaluate Bond Funds
Bond fund "SEC yield" is similar to YTM for the fund's holdings. Use it to compare fund expected returns.
Frequently Asked Questions
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