Yield to Maturity (YTM)
What is Yield to Maturity (YTM)?
Yield to maturity (YTM) is the total annual return an investor earns if a bond is bought at its current price and held until it matures.
YTM accounts for the purchase price, all coupon payments, and the face value repaid at maturity, so it reflects price gains or losses, unlike the fixed coupon rate. If a bond trades below face value, its YTM exceeds the coupon rate; if it trades above face value (at a premium), YTM is below the coupon rate. YTM and bond price move inversely.
Yield to Maturity (YTM): a worked example
A $1,000 face bond pays a 6% coupon, so $60, and matures in exactly one year. Buy it at $970 and the maturity payment is $1,000 + $60 = $1,060, giving a yield to maturity of $1,060 / $970 - 1 = 9.28%. The $30 discount adds 3.28 points on top of the 6% coupon. Buy the same bond at $1,030 instead and the yield is $1,060 / $1,030 - 1 = 2.91%, because the $30 premium disappears at maturity. Same bond, same coupon, and price alone moved the return by more than six points.
The mistake students make with yield to maturity (ytm)
The frequent mix-up is calling the current yield the yield to maturity. Current yield is just coupon divided by price, so a $60 coupon on a $970 bond gives 6.19%, which ignores the $30 the holder gains when the bond repays face value; the true yield to maturity there is 9.28%. Current yield is tempting because it takes one division and matches the yield to maturity when a bond trades at par, so the error stays hidden until the price moves off par.
Yield to Maturity (YTM) questions
What is the difference between yield to maturity and the coupon rate?
Yield to maturity measures the return on what you actually paid, while the coupon rate measures the payment as a share of face value. The coupon rate is fixed at issue and never changes; the yield to maturity moves every time the price moves. They are equal only when a bond trades at face value, and they separate the moment it trades at a discount or a premium.
Why is YTM higher than the coupon rate on a discount bond?
YTM is higher than the coupon rate on a discount bond because the buyer collects the coupons and a price gain as well. Paying $970 for a bond that repays $1,000 adds $30 of profit on top of the interest, and yield to maturity spreads that gain over the holding period. A premium bond works in reverse, since the buyer absorbs a loss at maturity that pulls the yield below the coupon.
Does yield to maturity change after you buy a bond?
Yield to maturity is locked in at purchase for a buyer who holds to maturity, is repaid in full, and reinvests coupons at that same yield, since price and payments are all known at the outset. What changes daily is the yield to maturity quoted in the market, recalculated from the current price for whoever buys today. A rising quoted yield means the price fell, which hurts a seller, not a holder.
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