Yield to maturity

Yield to maturity is the yield that a buyer of a bond will receive if he holds it to maturity. It is important to be able to calculate the yield to maturity in order to compare the possibilities of investing in different bonds in terms of yield. It is logical that investments in bonds with higher yields are more attractive.

But if comparing bonds with the same maturity is relatively simple, how do you account for the difference in price, maturity, and coupon?

The following parameters affect the profitability:

• the amount of the coupon payment,

• par and market price of the bond,

• term to maturity of the security.

 

To calculate the approximate yield to maturity, find the coupon payment, the bond’s par value, the price paid (per bond), and the number of years to maturity. Substitute the found data into the following formula:

Estimated yield to maturity = (C + ((F-P) / n)) / (F + P) / 2.

C – coupon payment, that is, interest payments on the bond, which are made in favor of its holder once a year.

F is the par value of the bond.

P is the price paid for the bond.

n is the number of years to maturity of the bond.

For example, the coupon payment for a bond is 100 USD, the par value of the bond is 1000 USD, the value of the bond is 950 USD, and there are 7 years left until the maturity date. Let’s calculate the yield to maturity:

Yield to Maturity = (100 + ((1000-950) / 7)) / (1000 + 950) / 2 = 0.1098.

Total, the yield to maturity is 10.98%. A pattern is visible: the less time remains until maturity, the greater the potential yield to maturity (with unchanged other parameters of the bond). In practice, however, the difference will be compensated for by the higher price of the short duration bond, and usually the yield is higher for the longer maturity bonds.

 

Calculating the yield to maturity will help you to select the comparatively more profitable bonds in your portfolio.