Yield to maturity is the estimated rate of return on a bond if it is held until the maturity date after factoring in all the interest received during the holding period. Yield to maturity is also known as ‘book yield’ or ‘redemption yield” which is similar to the current yield which divides the annual cash inflow from a bond.
Generally when understanding bond investment instruments you’d come across two bits of information, first, yield to maturity and second, coupon rate. Now yield to maturity as discussed already is the estimated rate of return on a bond if it is held until the maturity date. In other words, it is the internal rate of return (IRR) of an investment in a bond. The coupon rate is the earnings an investor can expect to receive from holding a particular bond. However, the coupon rates are fixed when the government or a corporation issues the bond.
Due to their low-risk compared to other investment instruments, bonds are generally looked upon as retirement goals. Now when a bond is first issued, the coupon rate and yield are the same but tend to change depending on the interest rate rise and fall or the rate offered by the government or corporation.
Yield to maturity is the total returns an investor can expect from a bond if held until maturity. It is expressed as an annualised rate of return. Both, yield to maturity and coupon payments are be computed on a semi-annual basis.
When computing yield to maturity it is assumed that all coupon payments are reinvested at the same rate as the bond’s current yield. The current market price, par value, coupon interest rate and time to maturity are taken into account. Yield to maturity expresses the value of different bonds on the same terms and becomes a measure to compare various bonds with different maturities and coupon structures. Through this computing, one can get a useful estimate on whether a certain bond is a good investment or not.
When you calculate the yield to maturity you can compare the expected return with other securities and as an investor, it is important you understand how yields vary with market prices and the effects it would have on your portfolio.
Here is how you can compute yield to maturity.
The current 10-year G-sec yield is 7.41 as of Feb 26, 2019.YTM = annual interest + (face value – current value) / no. of years to maturity
(Face Value + Current Value)