Understanding Yield to Maturity in Financial Terms

Pages: 3 (1095 words) Published: January 14, 2009

Yield to Maturity Paper
University of Phoenix

Yield to maturity (YTM) is a financial term that is not a concept that the everyday person comes in contact with. The definition of Yield to maturity according to Block and Hirt is “The yield to maturity, or discount rate, is the rate of return required by bondholders” (Block and Hirt, 2004). Even after reading the definition, it may not make sense without further explanation and examples given for clarity. Another definition found states “The rate of return anticipated on a bond if it is held until the maturity date. YTM is considered a long-term bond yield expressed as an annual rate. The calculation of YTM takes into account the current market price, par value, coupon interest rate and time to maturity. It is also assumed that all coupons are reinvested at the same rate. Sometimes this is simply referred to as "yield" for short” (Yield to Maturity, 2008). YTM is a measurement of the return of the bond. Several factors influence the yield to maturity. Some of the factors are the required rate of return, inflation premium, and the risk premium. In this paper, these three factors will be discussed. Influencing Factors

The yield to maturity, or discount rate, is the rate of return required by bondholders. The bondholder, or any investor for that matter, will allow three factors to influence his or her required rate of return (Block and Hirt, 2004). The three factors that will be discussed are real rate of return, risk premium and the inflation premium. Factor one is the real rate of return (ROR): “The annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other external effects. This method expresses the nominal rate of return in real terms, which keeps the purchasing power of a given level of capital constant over time” (Real Rate of Return, 2008). If the formal rate of return is adjusted to compensate...

References: Block-Hirt. (2004). Foundations of Financial Management. New York: McGraw-Hill
Inflation Premium. BusinessDictionary.com. (2008). Retrieved 06/06/2008 from: http://www.businessdictionary.com/definition/inflation-premium.html
Real Rate of Return. Investopedia. (2008). Retrieved 06/06/2008 from: http://www.investopedia.com/terms/r/realrateofreturn.asp
Real Rate of Return on Investments. About.com: Stocks. (2008). Retrieved 06/06/2008 from: http://stocks.about.com/od/understandingstocks/a/Realret020105.htm
The I Bond. BankRate.com. (2008). Retrieved 06/06/2008 from http://www.bankrate.com/brm/green/investing/investing3-2a.asp?caret=13
Yield to Maturity. Investopedia. (2008). Retrieved 06/05/2008 from: http://www.investopedia.com/terms/y/yieldtomaturity.asp
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