What is Yield to Maturity (YTM)? Definition and Formula
As one of the basic metrics used by investors, the yield to maturity (YTM) represents the expected annualised return that a bond investment can generate. Investors can use the YTM to compare bonds with different prices, coupons and maturities. Find out how YTM works, how to calculate it, and why it matters for investors.
Key takeaway
Yield to maturity (YTM) accounts for price, coupon, and time to maturity, making it a better measure of expected annualised returns than coupon rate or current yield alone. The predicted return figure assumes that all coupon payments are reinvested at the same rate. Capital at risk. The value of investments can go down as well as up, and you may get back less than you invest.
What is yield to maturity and how does it work?
When the phrase “yield to maturity” (or YTM) is spoken of in investment terms, it’s referring to the predicted annualised return that a bond can generate. This figure assumes that the bond is bought at the current market price, that all coupon (interest) payments paid to the holder by the issuer are reinvested at the same rate or yield, and that it is held until maturity (the date the issuer is required to pay back the holder).
The purchase price is a key influence over YTM, as buying a bond for less than its face value (a discount bond) means that the YTM will be higher than the coupon rate, which tends to generate extra profit upon maturity. Buying a bond for more than its face value (a premium bond) has the opposite effect - the YTM will be lower than the coupon rate, with a lower return on payday.
As well as holding the bond until maturity and reinvesting interest payouts, YTM also assumes that the company or government issuing the bond doesn’t default on its payment obligations.
A YTM formula: calculating yield to maturity
This is a simplified approximation; precise YTM calculations typically require financial software or iterative methods. A simple yield to maturity formula for calculating a bond’s approximate annualised return is as follows:
YTM = C + (FV - PV) / t
÷
(FV + PV) / 2
In the formula, C refers to the coupon payment, or the annual interest paid by the bond issuer. FV stands for face value (also referred to as par value), or the base amount the issuer promises to pay back the investor when the bond reaches maturity. It set by the issuer on day one, and generally doesn’t change (except in the case of inflation-linked bonds). PV refers to the bond’s present value, or its current market price. t is the number of years until the bond reaches maturity.
YTM vs. coupon rate vs. current yield - a comparison
Bonds have a few different metrics attached to them, namely the YTM, coupon rate, and current yield. There are key differences between them, which are outlined in the table below.
| Metric | What it measures | What it accounts for | When to use it |
| Coupon rate | The fixed annual interest rate set when the bond is issued, as a % of face value | Nothing else - it typically never changes over the bond's life | For knowing the fixed cash income you'll receive each year |
| Current yield | Annual coupon payment divided by the bond's current market price | Price changes since issuance, but not time value of money or capital gain/loss at maturity | Comparing income return if you might sell before maturity |
| Yield to maturity (YTM) | Annualised return if bought at current price and held to maturity, with coupons reinvested | Price, coupon, time to maturity, and capital gain/loss at redemption | Comparing bonds with different prices, coupons, and maturities on a like-for-like basis |
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What affects yield to maturity?
Four key components influence the YTM: a bond’s current market value, coupon rate, number of years remaining until maturity, and face value. These in turn are affected by external economic factors like the BoE base rate, inflation and the credit risk attached to a bond issuer. The key components have been covered already, so the below points look at the external factors that influence YTM.
1. BoE base rates
Rising interest rates drive up YTM, whereas falling rates lead to lower YTM. Higher interest rates cause bond prices to drop, as the new bonds issued with higher rates make the existing ones with lower rates less attractive to investors.
2. Inflation
Bond investors want a return that beats, rather than just matches, inflation. If investors expect inflation to rise, they look for a higher yield to compensate for the fact that their fixed coupon payments and the bond's face value will be worth less in real terms by the time the bond reaches maturity. This pushes bond prices down and YTM up.
3. Issuer credit risk
As with all investments, there is a risk vs. reward balance to strike. Bond issuers deemed to be risky, for example if they have previously defaulted on coupon payments, or are based in a country (or are the government of that country) with a low credit rating, often need to offer higher yields to attract investors. A bond with a longer time to maturity may also be considered risky.
Whether you choose a higher yield with a greater degree of non-payment risk, or lower yield with potentially lower risk, depends on your individual risk tolerance and existing portfolio makeup.
Quick fact
There is a distinction between nominal (not adjusted for inflation) and real YTM, which is the nominal YTM minus expected inflation. This is a truer reflection of an investor’s real terms returns potential. A bond can have a rising nominal YTM while its real YTM stays flat or even falls, if inflation is rising just as fast.
Why does yield to maturity matter for investors?
YTM, by and large, gives investors an indication of the returns they can expect by buying a bond at the current market price, reinvesting coupons, and holding to maturity. It is therefore a consistent indicator for comparing different bonds with different prices, time to maturity, or interest rates. YTM also gives a clearer indication of a bond’s true value, by factoring in whether or not you bought a discount or premium bond.
The value of investments can go down as well as up, and you may get back less than you invest.
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Yield to maturity FAQs
What is yield to maturity?
Yield to maturity is the total annual return you'd earn if you bought a bond today and held it until it pays back its full face value, assuming every coupon payment is made on time and reinvested at the same rate.
How do you calculate yield to maturity?
Yield to maturity is calculated by adding the bond's annual coupon payment to the difference between its face value and current market price, divided by the number of years to maturity. That figure is then divided by the average of the face value and current market price (i.e. the two added together and divided by 2).
What's the difference between yield to maturity and coupon rate?
The coupon rate is a fixed percentage set when the bond is issued and never changes. Yield to maturity moves with the bond's market price, so it reflects the actual return an investor would get if they bought the bond today rather than at face value.
Why does yield to maturity change?
YTM changes as a bond's market price changes, and prices move in response to shifts in interest rates, credit risk, and time remaining to maturity. As a bond's price falls, its YTM rises, and vice versa.
Is a higher yield to maturity always better?
Not necessarily. A higher YTM can reflect greater risk, such as a lower credit rating or longer time to maturity, rather than simply a better deal, so it's worth weighing YTM alongside the issuer's creditworthiness and your own investment goals.
Important to know
This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
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