Yield to Maturity
Yield to Maturity
Kindra Hill
University of Phoenix
MMPBL/503 Wk 5
June 27, 2010
Scenario: A coworker of yours was discussing her investments with a broker. Your coworker was confused because she had purchased a 10% bond but the broker kept repeating that it had a 9% yield to maturity. Explain the concept of yield to maturity. This paper will explain the concept of yield to maturity in reference to bonds. It will allow for understanding of the difference in the stated rate of the bond and the yield to maturity. Explanation of this concept will allow the coworker in the scenario to understand what the broker is meaning by his statements. Yield to maturity (YTM) is the amount an investor can expect to receive from a long term bond if held to maturity and all coupons are reinvested at the same rate back into the bond. “YTM is considered a long-term bond yield expressed as an annual rate” (Investopedia, 2010). Redemption value, time to maturity, time between interest payments and coupon yield are all taken into consideration when calculation the YTM of a bond, per the Dictionary of Finance and Accounting (2006). A coupon is the interest rate stated on a bond when it is issued and is typically paid semi-annually (Investopedia, 2010). According to the Dictionary of Finance and Accounting terms, calculation of YTM is the same as calculation of IRR, and it is calculated by trial and error to find the discount rate at which the present value of the future bond payments would equal the present price of the bond (2006). This requires the use of a business calculator. The formula used to calculate the YTM, according to Block & Hirt (2005) is: [pic][pic]
The advantage of calculation of YTM is that it allows an investor to compare options easily. Keep in mind when making an investment in a bond is that the interest rate may change due to external forces, but the YTM is set at the time of purchase and doesn’t change as
Kindra Hill
University of Phoenix
MMPBL/503 Wk 5
June 27, 2010
Scenario: A coworker of yours was discussing her investments with a broker. Your coworker was confused because she had purchased a 10% bond but the broker kept repeating that it had a 9% yield to maturity. Explain the concept of yield to maturity. This paper will explain the concept of yield to maturity in reference to bonds. It will allow for understanding of the difference in the stated rate of the bond and the yield to maturity. Explanation of this concept will allow the coworker in the scenario to understand what the broker is meaning by his statements. Yield to maturity (YTM) is the amount an investor can expect to receive from a long term bond if held to maturity and all coupons are reinvested at the same rate back into the bond. “YTM is considered a long-term bond yield expressed as an annual rate” (Investopedia, 2010). Redemption value, time to maturity, time between interest payments and coupon yield are all taken into consideration when calculation the YTM of a bond, per the Dictionary of Finance and Accounting (2006). A coupon is the interest rate stated on a bond when it is issued and is typically paid semi-annually (Investopedia, 2010). According to the Dictionary of Finance and Accounting terms, calculation of YTM is the same as calculation of IRR, and it is calculated by trial and error to find the discount rate at which the present value of the future bond payments would equal the present price of the bond (2006). This requires the use of a business calculator. The formula used to calculate the YTM, according to Block & Hirt (2005) is: [pic][pic]
The advantage of calculation of YTM is that it allows an investor to compare options easily. Keep in mind when making an investment in a bond is that the interest rate may change due to external forces, but the YTM is set at the time of purchase and doesn’t change as
References: Block, S.B., & Hirt, G.A. (2005). Foundations of Financial Management Chapter 10: Valuation and Rates of Return (11th ed.) Shelton, L. (2010, June 28). Yield to Maturity [MMPBL/503 Wk 5: Capitol Valuation and Bonds] thread.jspa?threadID=22965742 Unknown, (n.d.), Retrieved on June 27, 2010 from: http://www.investopedia.com/terms/c/coupon.asp Unknown, (n.d.), Retrieved on June 27, 2010 from: http://www.investopedia.com/search/searchresults.aspx?q=yield+to+maturity&submit YIELD TO MATURITY (YTM). (2006). In Dictionary of Finance and Investment Terms