Yield to maturity

The yield to maturity refers to the yield or rate of return on a bond if it is held until maturity. It is expressed as an annual rate. Yield can arise either from coupons or capital gains.

When someone purchases a bond, he lends money to the issuer.

If all goes well and the issuer does not default, the buyer of the bond is reimbursed 100% of the principal at maturity.

However the purchase price of a bond may be less than or greater than 100%.

Take, for example, a 3-year bond with a face value of USD 100, that pays a 3% coupon and is issued at 95%. the buyer (borrower) pays USD 95 to buy the bond, but will be reimbursed USD 100 in two years. He will also receive 3% interest on the face value the lender (USD 3).

Thus the YTM would be calculated as follows:

The interest rate (i) or yield that solves this equation is the yield to maturity. In this case, 4.83%.