Yield to maturity

What yield to maturity assumes

YTM assumes the investor holds the bond to its stated maturity, all contractual payments occur in full and on time, and interim coupons can be reinvested consistently with the calculation. It is an internal rate of return based on promised cash flows, not a guaranteed realized return. Callable, puttable, floating, defaultable, or path-dependent bonds require additional yield and scenario measures.

How it is calculated

The bond price equals the sum of discounted coupon and principal cash flows, using a rate consistent with payment frequency and day-count convention. The rate is solved numerically. Quotation conventions vary by market, so a nominal annual yield with semiannual compounding is not identical to an effective annual yield even when both describe the same price.

Example

A bond bought below par can have YTM above its coupon because the investor expects coupon income plus movement toward par at maturity. A premium bond generally has YTM below its coupon because part of the coupon is offset by movement down toward par. Credit loss or an early sale can prevent either expected path from being realized.

How to interpret it

Compare YTM only among bonds using compatible conventions, currencies, maturities, credit quality, and optionality. For callable bonds, yield to worst may be more relevant. Separate government-curve yield from credit spread and other components. A quoted yield can rise because the bond became cheaper for attractive reasons, or because its risk and expected loss increased.

Limitations

YTM compresses a complete cash-flow schedule into one rate and embeds a reinvestment assumption. It uses contractual rather than probability-weighted cash flows and can overstate expected return for risky debt. It also ignores taxes, transaction costs, liquidity, and the investor's actual horizon. Multiple or ambiguous solutions can arise for unusual cash-flow patterns.

Practical checklist

Validate price type, settlement date, accrued interest, cash flows, frequency, day count, maturity, calls, and currency. Recalculate yield independently and state its compounding convention. Review yield to call and worst, spread, duration, expected default loss, and scenario return. Never present YTM as the return an investor will certainly earn.

Sources and further reading

• Bonds: Frequently Asked Questions, Investor.gov, U.S. Securities and Exchange Commission