When it comes to investing, what is yield to maturity (YTM) and how do you calculate it? We explain the answers in this straightforward guide. There are many investment terms out there that might confuse you, but none more than yield to maturity (YTM). There are many nuances to understanding YTM.
If you are having a hard time understanding YTM, then you are in the right place. We will make it easy for you to understand and calculate YTM.
Read on to see what is yield to maturity and how to calculate YTM.
What Is Yield to Maturity?
Yield to maturity is also known as redemption or book yield. It is a speculation on the rate of return of fixed-rate securities, like bonds.
Remember that YTM calculations assume that the investor would purchase the security, pay all interest and coupon payments on time, and hold it until maturity.
YTM is the long-term yield of the bond, BUT it is expressed as an annual rate. This is important to know when doing YTM calculations.
How to Calculate YTM
You will see many different formulas to calculate YTM online. The formula that we recommend here is as follows:
YTM = (C+((FV-PV)/t))/(FV-PV)/2
- C – Interest/coupon payment
- FV – Face value of the security
- PV – Present value/price of the security
- t – Years it takes the security to reach maturity
Don’t be alarmed looking at this formula. It’s not as complicated as it looks. But more importantly, if you are uncomfortable doing Math, then there are calculators online that can help you with your YTM calculations.
All you would need to do then is plug in all the information you have on your particular fixed-rate security and voila, you will receive your YTM.
If you are searching for high-yield and high-interest investment opportunities, then you will need to become more aware of how to calculate YTM for potential securities.
Without doing YTM calculations, you are making a gamble on a fixed-rate security that might end up being a complete dud.
It’s also useful to do YTM calculations because they help you compare different securities. You can see what returns you would be able to expect from each security and which one is a more worthy investment.
You also need to understand that market conditions will affect your investment returns, and that will affect your portfolio.
Remember, the formula is when securities drop in price, yields rise, and vice versa. This way you can watch how the market behaves and get in when the market is good for a bond investor like you.
Yield to Maturity 101
Now that you have the basics of yield to maturity down, you can start using this formula and doing YTM calculations to gauge whether a particular investment is worth it or not.
No more dipping your money into investments based on a whim or a ‘gut feeling’. Make your decisions more concrete by using YTM calculations.
Did you find this article useful? If you learned something from this article, don’t forget to check out the other personal finance articles here on our website.