What Is Yield to Maturity?
Yield to maturity is the internal rate of return on a bond purchased today and held to its final payment. It captures both the coupon income and any gain or loss from buying the bond above or below face value, expressed as one annualized number. When a bond trades at par, YTM equals the coupon rate; below par it exceeds the coupon, and above par it falls short.
YTM is the yield quoted on trading screens and used to compare bonds with different coupons and maturities on equal footing. It assumes the issuer pays in full and that every coupon is reinvested at the same YTM, an assumption that rarely holds exactly but keeps the measure consistent across the entire market.
How to Calculate It
YTM is the rate y that solves: Price = C/(1+y) + C/(1+y)^2 + ... + (C + Face)/(1+y)^n, where C is the annual coupon and n is the years to maturity. Because y cannot be isolated algebraically, it is found by iteration, which is what a financial calculator or Excel's YIELD function does behind the scenes.
A quick approximation is YTM ≈ [C + (Face − Price)/n] ÷ [(Face + Price)/2]. For an 8-year bond with a $1,000 face value and a 6% coupon trading at $920: [60 + 80/8] ÷ 960 ≈ 7.3%. U.S. bonds pay semiannual coupons, so convention is to solve for a semiannual rate and double it, producing the bond-equivalent yield.
Why It Matters
YTM is the common language of fixed income. The yield curve is a plot of Treasury YTMs across maturities, and the spread between a corporate bond's YTM and that curve measures credit risk. When commentators say yields rose, they mean YTMs increased and bond prices fell correspondingly, since the two always move in opposite directions.
Its limitations matter too. YTM overstates the expected return on callable bonds trading above their call price, which is why analysts check yield to worst, and it ignores default risk, so a distressed bond can show a 25% YTM the issuer will never actually pay. Interviewers often test whether candidates can explain the inverse price-yield relationship and the reinvestment assumption behind the measure.
