Yield to Maturity (YTM)
Definition of 'Yield to Maturity (YTM)'
Yield to maturity (YTM) is the total return of anticipated return on a bond based on the term. Another popular bond measurement is current yield.
TheStreet Explains ‘Yield to Maturity (YTM)’
If the investor plans to hold the bond until its term or maturity date, yield to maturity predicts the realized return. Typically expressed as an annual rate, yield to maturity takes into consideration the cumulative bond coupons until the bond is fully mature. A bond coupon is the annual rate of return, which is the amount of interest the investor will earn on an annual (and not term) basis.
To calculate YTM, the investor must know the market price, yield to maturity, also known as book yield or redemption yield, par value and coupon’s rate of interest. The calculation assumes all coupon rates will remain the same at the current yield.
While not an exact science since market rates tend to fluctuate not only annually, but also on a monthly and even daily basis, yield to maturity allows investors to predict what they could earn from a bond once it matures, while at the same time comparing and contrasting the YTM of other bonds in the market. This will also allow the investor to determine which bond will possibly produce a better return.
Because not all bonds will be kept until maturity, investors also like to measure the bond’s current yield to determine the coupon’s value/worth on an annual basis. To calculate the current yield, simply divide the interest paid annually by the bond’s current price.
Because bond prices are constantly in flux, the total price may differ if the investor wants to sell prematurely. Because prices may dip during the bond’s life, the investor may lose some money if it is sold before the term is over. The investor may still earn the coupon amount, but may take a loss during the bond sale.
Drawbacks to yield to maturity include not taking taxes into consideration, which means YTM actually means gross redemption yield. Additionally, the purchase of goods and selling costs are not configured into the YTM calculation. The other drawback to the YTM calculation is that this is a predictive tool and not an absolute measure of return. Market fluctuations can greatly influence the investor’s rate of return--both on a negative but also positive level.
Terms Related to 'Yield to Maturity (YTM)':
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