Expressed simply, the yield to maturity (YTM) of a bond is the annualized return that a bond investor would receive from holding the bond until maturity. It is also referred to as the redemption yield or the book yield.
More technically, it is the internal rate of return required for the present value of all future cash flows from the bond – its coupon payments and the principal – to equal the prevailing market price of the bond.
The calculation of the YTM is an iterative process, in which a range of rates are substituted into the formula. The YTM is determined once the calculated price (the present value of future cash flows) equals the current market price.
The YTM can be used to evaluate the current valuation of a bond by comparing it with its coupon rate, where the latter is a simpler calculation of the annual coupon payments divided by the face value of the bond.
If the YTM is higher than the coupon rate, the bond is trading at a discount. If the YTM is below the coupon rate, the bond is trading at a premium.
Furthermore, as the YTM is calculated as an annualized rate, it can be used to compare the relative attractiveness of bonds with different coupons and maturities.
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