What is Yield to Maturity?
Yield to Maturity (YTM) is also known as the final yield, which refers to the rate of return an investor can expect if they hold a bond until its maturity date. YTM is an important indicator for investors when purchasing bonds as it shows the level of return an investor can achieve by holding the bond until maturity.
The yield to maturity of a bond is related to its face value, coupon rate, remaining term, and current market interest rates. Generally, YTM has an inverse relationship with the bond’s coupon rate. When a bond’s coupon rate is higher than the current market interest rate, the YTM will be lower than the coupon rate, and vice versa. This is because the market price of bonds fluctuates according to market interest rates, while the bond’s coupon rate is fixed at issuance, thus these market price fluctuations affect the yield to maturity.
Types of Yield to Maturity
Based on different actual returns after holding to maturity, YTM can be divided into three types.
- Nominal Yield to Maturity (NYTM): This is calculated based on the bond’s coupon rate without considering factors like purchase price, remaining term, and interest payment method, hence it cannot reflect the real return level of the bond.
- Real Yield to Maturity (RYTM): This considers factors such as the bond’s purchase price, remaining term, and interest payment method, and is calculated using compound interest. This yield can reflect the true return level of the bond.
- After-tax Yield to Maturity (AYTM): This is the yield after considering the taxes required to be paid on the bond’s interest, reflecting the yield level under the tax policy.
Characteristics of Yield to Maturity
The characteristics of YTM mainly include the following aspects.
- Comprehensive Indicator: It is a comprehensive indicator of bond investment, considering all cash flows an investor can obtain by holding the bond until maturity, including coupon income and principal recovery.
- Annualized Representation: Usually expressed in annualized form, allowing for comparison of bonds with different maturities and coupon rates, enabling investors to better evaluate bond returns.
- Real Return: It reflects the annual average return an investor can obtain by purchasing at the current market price and holding until maturity, considering time value and compound interest calculations, thus showing the real return level of the bond.
- Inverse Relationship with Bond Price: There is an inverse relationship between YTM and bond price. When bond price rises, YTM falls, and when bond price falls, YTM rises.
- Influenced by Market Interest Rates: There is a positive relationship between YTM and market interest rates. When market interest rates rise, YTM rises, and when market interest rates fall, YTM falls. This is because market interest rates reflect the discount rate applied to future cash flows, leading to changes in YTM.
- Affected by Remaining Term: YTM is also influenced by the bond’s remaining term. Generally, the longer the remaining term, the higher the YTM, and the shorter the remaining term, the lower the YTM.
Factors Influencing Yield to Maturity
YTM is influenced by multiple factors, including but not limited to the following.
- Purchase Price: There is an inverse relationship between purchase price and YTM. When bond prices rise, YTM decreases, and when bond prices fall, YTM increases.
- Market Interest Rates: There is a positive relationship between market interest rates and YTM. As market interest rates increase, YTM increases, and as market interest rates decrease, YTM decreases.
- Redemption Price: There is a positive relationship between redemption price and YTM. The higher the bond’s redemption price, the higher the YTM; the lower the redemption price, the lower the YTM.
- Holding Period: There is a positive relationship between holding period and YTM. Generally, the longer the remaining term, the higher the YTM; the shorter the remaining term, the lower the YTM.
- Interest Payment Method: There is also an inverse relationship between interest payment frequency and YTM. The higher the payment frequency, the lower the YTM; the lower the payment frequency, the higher the YTM.
- Credit Risk: Credit risk refers to the default risk of the bond issuer. Bonds with higher credit risk usually have a higher YTM, while bonds with lower credit risk usually have a lower YTM.
- Premium or Discount: Premium or discount affects YTM. Premium bonds have a YTM lower than the coupon rate, while discount bonds have a YTM higher than the coupon rate.
- Inflation Expectations: There is a positive relationship between inflation expectations and YTM. The higher the inflation expectations, the higher the YTM; the lower the inflation expectations, the lower the YTM.
