Yield to Maturity (YTM)
Buy at today's price and hold to maturity: what's your annual return really? YTM counts both the coupons and the price difference.
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Text version · Bonds & Fixed Income, lesson 3: “Yield to Maturity (YTM)”
Buy at today's price and hold to maturity: what's your annual return really? YTM counts both the coupons and the price difference.
YTM counts the price difference too
yield to maturity (YTM) = the true annual return if you hold to maturity: it includes both the yearly coupon and the difference between your purchase price and the face value.
The rate that makes the sum of present values = price
Discount each future cash flow at some rate to its present value; if they add up exactly to today's price, that rate is the YTM.
Current yield only looks at the coupon
current yield = annual coupon ÷ price: $50 ÷ $950 ≈ 5.26%. It leaves out the extra $50 you get back at maturity, so the 5-year YTM (about 6.19%) is higher.
Key takeaways
- YTM is the rate that makes the discounted value of all future cash flows equal the current price.
- Bought at a discount: YTM > coupon rate. Bought at a premium: YTM < coupon rate.
- Current yield = annual coupon ÷ price. It looks only at interest, not the price difference at maturity, so it differs from YTM.
- YTM assumes you hold to maturity, there's no default, and coupons are reinvested at the same rate.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click “Example $950 · 5%” and play (keep the maturity at 5 years): what's the YTM? Higher or lower than the 5% coupon rate?
- Click “Par $1,000”: how do the YTM and the coupon rate compare?
- Drag the price to $1,100: why don't the present-value bars stack up as high as before? What does YTM become?
- Keep $950 and drag the maturity from 10 years to 1 year: with the same $50 difference, why does YTM go up?
Quiz and explanations
- 1. You buy a $1,000 face value bond with a 5% coupon for $950. Its YTM will be…
- Answer: Above 5%.On top of the coupons, you gain an extra $50 price difference at maturity.
- 2. If you buy at face value and hold to maturity, YTM equals…
- Answer: The coupon rate.There's no price difference, so your return is just the coupon.
- 3. A bond with a $1,000 face value and a 5% coupon now costs $1,250. What's its current yield?
- Answer: 4%.$50 ÷ $1,250 = 4%. Bought at a premium, its YTM is even lower, because you lose the $250 price difference at maturity.
Terms in this lesson
- coupon (Coupon): The interest paid regularly to bondholders based on the coupon rate.
- coupon rate (Coupon Rate): The coupon as a percentage of face value, set at issue and usually fixed.
- current yield (Current Yield): Annual coupon ÷ current price; it only counts yearly interest, not the price difference at maturity, so it differs from yield to maturity.
- present value (Present Value): What a future amount of money is worth today after discounting at an interest rate.
- yield to maturity (YTM) (YTM): The annual return from buying at today's price and holding to maturity, counting both coupons and the price difference.