The Yield to maturity (YTM) or redemption yield of a bond or other fixed-interest security, such as gilts, is the internal rate of return (IRR, overall interest rate) earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity, and that all coupon and principal payments will be made on schedule. Contrary to popular belief, including concepts often cited in advanced financial literature, Yield to maturity does NOT depend upon a reinvestment of dividends. Yield to maturity, rather, is simply the discount rate at which the sum of all future cash flows from the bond (coupons and principal) are equal to the price of the bond. The YTM is often given in terms of Annual Percentage Rate (A.P.R.), but more usually market convention is followed: in a number of major markets the convention is to quote yields semi-annually (see compound interest: thus, for example, an annual effective yield of 10.25% would be quoted as 5.00%, because 1.05 x 1.05 = 1.1025).
The yield is usually quoted without making any allowance for tax paid by the investor on the return, and is then known as "gross redemption yield". It also does not make any allowance for the dealing costs incurred by the purchaser (or seller).
- If the yield to maturity for a bond is less than the bond's coupon rate, then the (clean) market value of the bond is greater than the par value (and vice versa).
- If a bond's coupon rate is less than its YTM, then the bond is selling at a discount.
- If a bond's coupon rate is more than its YTM, then the bond is selling at a premium.
- If a bond's coupon rate is equal to its YTM, then the bond is selling at par.
Read more about Yield To Maturity: Variants of Yield To Maturity, Formula For Yield To Maturity, Example
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