Investing in bonds is another way of putting your money to work for you. But, how profitable is it for you? There are many kinds of bonds available for investment. They offer different returns on various terms. Yield to maturity is the method that is useful to determine the total return on a bond if it is held until maturity. In this Yield to maturity guide with supporting online calculator we look at how to measure your investment and the approaches used in the Yield to Maturity measurement.
|Par / Face Value
|Years to Maturity
|Yield to Maturity (YTM)
Please provide a rating, it takes seconds and helps us to keep this resource free for all to use
Yield to maturity also known as book yield is calculated to estimate the rate of return on long term or a fixed rate security investments, however, it is expressed as an annual rate. This method assumes that the bond is purchased at the market price and all the coupon and interest payments are made as per schedule. Let's take a look at the method of calculation of yield to maturity.
Calculating yield to maturity manually is a complex task, we can start by calculating the estimated yield to maturity for basic understanding. You can calculate the yield to maturity using the following formula:
Let's understand it better with an example, we will use Euros as an example currency but first we will put the formula into a more relatable layout for ease of reading:
Consider a bond with a par value of €1,000 and a current market value of €950, that pays an annual interest rate of 7% (€70) and matures in 4 years, let's see the calculations to satisfy the equation.
The result obtained from the above is 11.25% because the yield to maturity is an interest rate that you earn by reinvesting the value of each bond at a constant rate until the bond reaches its maturity. You will have the maturity date, coupon price, and current bond price, but the interest rate that is used for discounting to determine the present value cannot be calculated directly. This requires trial and error method for finding out YTM for present value.
Instead of going through the complex calculations manually, you can take advantage of online tools like calculating software or online calculators such as Yield to maturity calculator by iCalculator. Let's see what are the inputs required for using the calculator.
The following inputs are required in order to get the results:
On the basis of the above inputs the calculator will provide you with Yield to maturity percentage. The benefits of using the calculator is not only limited to making your complex calculations easier, you also save a lot of time.
The results from the calculator can be used further to make comparisons with the other bond investment opportunities in order to get the best out of your investments.
The obtained value of yield to maturity from the calculator is useful in determining if buying a bond is a good investment. The calculator shows you the results as an annual percentage, so you can use the calculator for estimating YTM for bonds with different maturity periods. This can be done by just changing the years to maturity value.
As discussed above the yield to maturity method is quite useful, but like any other financial method it comes with certain limitations. Let's take a brief look at the drawbacks of YTM.
The yield to maturity method is also known as gross redemption yield and as the name suggests it does not show the net redemption amount. YTM ignores the fact that an investor has to pay some amount of tax on the redemption, thus making the value obtained with YTM a bit unrealistic.
The buying and selling costs are also not considered while calculating YTM. Additionally, the method is based on many future assumptions, such as the reinvestments of all the coupons, and the bonds are held until maturity. There is always a possibility that investors may redeem the bonds before maturity or they might not reinvest the coupons.
You may also find the following Finance calculators useful.