Yield to maturity (YTM) is a financial metric used to estimate the total return an investor can expect to receive from holding a bond until it matures. YTM takes into account the bond's current market price, its face value, the coupon rate, and the time remaining until maturity. It represents the annualized rate of return that an investor would earn if the bond is held until maturity and all coupon payments are reinvested at the YTM rate.
The following formula is used to calculate the yield to maturity of the bond:
Yield to maturity = (Annual coupon + (Face value – Current close) ÷ Years to maturity) ÷ ((Face value + Current close) ÷ 2) * 100
Annual coupon: This represents the annual interest payment received from the bond, based on the coupon rate and the bond's face value.
Face value: This is the nominal value of the bond that will be repaid to the bondholder at maturity.
Current close: This refers to the current market price of the bond.
Years to maturity: This indicates the remaining time until the bond reaches its maturity date.
Yield to maturity is a crucial measure as it provides a more comprehensive view of the bond's potential return compared to the current yield. YTM considers not only the periodic interest payments but also any capital gains or losses that may occur if the bond is held until maturity.