Yield to maturity (YTM) is basically the internal rate of return (IRR) that makes all the future cash flows from a bond equal to its current price. It assumes you hold onto the bond until it matures and that you can reinvest at the same yield.
Formula of Yield to Maturity
You can figure out a bond’s YTM using this formula:
YTM = [ C+ (FV - PV) ÷ t ] ÷ [ (FV + PV) ÷ 2 ]Where:
- C = Coupon Payment
- FV = Face Value
- PV = Present Value/Current Price
- t = Years to Maturity
Is Higher or Lower Yield to Maturity Better?
It all comes down to the market. If the YTM is greater than the current yield, the bond could be a bargain, suggesting it’s a good time to buy. On the flip side, if the YTM is less than the current yield, it might mean the bond is overpriced and could be a good candidate for selling.
Conclusion
The yield to maturity of a bond is basically the internal rate of return that makes the present value of all future cash flows, like the face value and coupon payments, match the current price of the bond. It also assumes that all coupon payments are reinvested at the same yield as the YTM and that you hold onto the bond until it matures.