What is Yield to Maturity?
Yield to maturity (YTM) is a term that is related very closely to bonds and measures the cash flow of the investment over a period of time. It is the total return expected on a bond when the bond matures and is expressed as an annual return, which is why it is considered a long term bond yield.
Yield to maturity is quite similar to current yield except it accounts for the present value of a bond’s future coupon payments. Bonds are marketable securities, so their prices tend to fluctuate with the moving interest rates in the economy which makes them a pretty risky long-term investment.
Why is Yield to Maturity Important?
Yield to maturity is very important while calculating the bond price and you can do so by using the formula given below:
*Bond Price = i = 1nCoupon 1(1 + YTM)i+ Face Value(1 + YTM)n *
Where Bond Price = Current price of the bond
Coupon = Multiple interests received during the investment period (These are reinvested back at a constant rate.)
Face Value = The price of the bond set by the issuing authority
YTM = Yield to Maturity or Yield
This formula gives you a rough estimate as yield to maturity is just an approximate value.
Why is Yield to Maturity (YTM) useful?
Yield to Maturity can prove to be quite instrumental while determining if investing in a bond is a good idea or not. One can know this by calculating the yield of the bond and compare it with the yield required by the investor, to decide whether he or she needs to buy that bond or not.
The fact that YTM is expressed as an annual rate irrespective of the time taken by the bond to mature, can be used to compare bonds even when they have different maturities and coupons, which makes it a useful parameter to take into account while calculating bond price and returns.
