Summary of this article
Yield to maturity of a bond reflects all the returns and risk of a bond
Here is how to calculate the YTM of a bond
For bond investors, yield-to-maturity is a key concept to understand and compare different bonds and the choice of investments. This metric is used for evaluating the attractiveness and risks associated with particular fixed-income assets such as debt funds.
India’s 10-year benchmark government bond is currently giving a yield of 6.62 per cent while the coupon payment of the bond is at 6.48 per cent. The yield-to-maturity (YTM) of the bond shows how much an investor is willing to pay to hold a sovereign debt security of 10 years. The interest or the yield reflects the risk associated with holding the bond and is a metric of the total return an investor can expect if they hold the bond till it matures, including all the coupon payments.
For a particular investor, the YTM will be calculated on the basis of the simple average of the yield of all bonds that the person holds in the personal fund portfolio. Understanding how the YTM is calculated helps investors make informed decisions on whether or not to add a particular bond in their portfolios.
How Is YTM Calculated?
The YTM of a bond or a debt fund calculates the annual rate of return for an investor to hold the bond till maturity. To calculate the YTM, the face value of the bond, the buying price for the investor, the time remaining for the bond to mature, and the coupon rate of the bond are calculated. While calculating YTM, it is assumed that all interest coupon payments are reinvested at the same rate at the current yield as an ideal situation.
The YTM formula for a single bond considers the par value of the bond at the time of issuance and the current market price of the bond. It is as follows:
YTM= [Annual Interest + {(Face Value – Current Market Price) / Remaining Years to Maturity}] / [(Face Value + Current Market Price) / 2]
Suppose a bond is given at a face value of Rs. 100 with the current market price at Rs. 101, giving an annual coupon rate of 6.5 per cent, and a 10-year maturity time. In this case, the YTM becomes,
YTM= [6.5 + {(100 – 101) / 10}] / [(100 + 101) / 2] = 6.37 per cent
