Yield to Maturity
Updated on March 9, 2023
Yield to maturity (YTM) is the total return expected from a bond (or Debt security) if the bond is held until its maturity. Yield to maturity is a long-term bond yield but is expressed as an annual rate. In other words, it is the internal rate of return (IRR) for a bond if the investor holds the bond until maturity, with all interest payments made as per the schedule and also reinvested at the same rate. ‘Yield’ is the return that an investor gets from the bond in the specified time and can be calculated by dividing the interest by the bond price. ‘Maturity’ refers to the date on which the principal becomes due to be paid back to the bondholder.
Why is Yield to maturity important?
Yield to Maturity is an important metric for investors to make more informed investment decisions, like:
1. YTM can be compared with required yield from the bond before the investment decision
2. Investors can compare the bonds with different maturities and interest rates as YTM provides an annualized rate
3. Changes in market price mean profit or loss for the bond traders and thus YTM is a critical factor that they consider
What are the drawbacks of yield to maturity?
Certain limitations of YTM are:
1. It avoids the reinvestment risk because in YTM it is assumed that all the interest payments are reinvested. Reinvestment may not be a good option in all conditions
2. Although YTM is considered a good measure for estimating returns, it only gives an approximate and not the exact figure