The yield to maturity calculator (YTM calculator) is a handy
tool for finding the rate of return that an investor can
expect on a bond. As this metric is one of the most
significant factors that can impact the bond price, it is essential
for an investor to fully understand the YTM definition.
We have written this article to help you understand the
meaning of YTM, how to calculate it using the YTM
equation, and the factors that cause YTM to rise and fall.
We will also demonstrate some examples to help you understand the
concept more thoroughly.
Before we talk about the YTM calculation, we must first
understand what a bond is. A bond is a financial instrument
that governments and companies issue to get debt funding from the
public.
If you hold a bond, you are entitled to collect a fixed set of
cash payments. In practice, this means that until the bond matures,
you receive regular interest earnings or coupon payments.
When you arrive at the end of the bond's lifespan or maturity
date, you get not only the last interest payment but also
recover the face value of the bond, that is, the bond's
principal.
As bonds are a particular type of investment, their precise
evaluation is crucial in the eyes of investors. The most important
aspect of the assessment is whether money is made or lost on the
investment, that is, what is the return on the financial
transaction? And this is what YTM represents and what can be found
with this yield to maturity calculator.
The YTM can be thought of as the rate of return on a
bond. If you hold the bond to maturity after buying it in
the market and are able to reinvest the coupons at the YTM, the YTM
will be the internal rate of return (IRR) of your bond
investments.
Now that we know the YTM definition, let's take a look at some
examples to understand the YTM equation and its calculation.
The YTM formula needs 5 inputs:
bond price - Price of the bond;face value - Face value of the bond;coupon rate - Annual coupon rate;frequency - Number of times the coupon is
distributed in a year; andn - Years to maturity.
Let's take Bond A issued by Company Alpha, which has the
following data, as an example of how to find YTM:
- Lea hart porn: $980
- Face value: $1,000
- Annual coupon rate: 5%
- Coupon Frequency: Annual
- Years to maturity: 10 years
-
Determine the bond price
The bond price is the money an investor has to pay
to acquire the bond. It can be found on most financial data
websites. The bond price of Bond A is
$980.
-
Determine the face value
The face value is equivalent to the principal of
the bond. For our example, face value = $1,000.
-
Determine the annual coupon rate and the coupon
frequency
coupon rate is the annual interest you will receive
by investing in the bond, and frequency is the number
of times you will receive it in a year. In the yield to maturity
calculator, you can choose from six different frequencies, from
annually to daily.
In our example, Bond A has a coupon rate of 5% and
an annual frequency. This means that the bond will pay
$1,000 * 5% = $50 as interest each year.
-
Determine the years to maturity
The n is the number of years from now until the
bond matures. The n for Bond A is 10
years.
-
Calculate the YTM
The YTM can be seen as the internal rate of return of
the bond investment if the investor holds it until it
matures and reinvests the coupon at the same interest rate. Hence,
the YTM formula involves deducing the YTM r in the
equation below:
The yield curve is one of the best instruments to
analyze the evolution of YTM. The bond yield curve plots
the YTM against time.
For instance, if the yield curve is upward-sloping, the
long-term YTM, such as the 10-year YTM, is higher than the
short-term YTM, such as the 2-year YTM. On the other hand, if the
yield curve is trending downwards, the 10-year YTM will be lower
than the 2-year YTM.
Technically, yes. Bond yield will equal YTM if
you hold to the bond until its maturity and reinvest at the same
rate as the YTM.
The yield curve is a graph drawn for YTM against
time. It shows the evolution of YTM with time. If the
yield curve trends upwards, it means that the long-term YTM is
greater than the short-term YTM.
There are several factors that can make YTM fall. For instance,
the lower the inflation, the lower the YTM. Also,
the less volatile the market condition, the lower
the YTM.
Yes, YTM can be negative. It happens every now
and then, even though it is not common. This situation normally
happens when inflation is out of control and the market is
unstable.
In such a situation, even a negative YTM is still better than
storing cash since hyperinflation might happen.
