Yield is commonly used to refer to return in the fixed-income world; that is, investors want stock with high returns and bonds with high yield. Yield to maturity is a comparison measure for the annual return on a particular bond if held to maturity. The number of years to maturity is a given.
Review the formula to calculate the price of a bond. A bond equals the present value of its cash flows in the future. The formula is P = c(1 + r)^1 + c(1 + r)^2 + . . . + c(1 + r)^Y + B(1 + r)^Y, where P = current price of the bond, c = coupon payment, B = par value, and r = required rate of return on the investment. All of these variables can be found by looking up the ticker symbol (CUSIP) for the bond. Yahoo! Finance has a comprehensive database of bond pricing information.
Define your variables. For this example, let's say you own a bond that matures in 4 years, with a par value of $1000, current price of $950, and a coupon rate of 7 percent. You want to know the yield to maturity (YTM) on the bond. You can find this information by looking up the data for the bond you are interested in. The information will be listed under the same variables listed here. For instance, if you do a search for IBM bonds on Yahoo! Finance you will be given the price, coupon percentage, maturity, YTM percentage, current yield, rating, and call status.
Calculate the coupon payment. The coupon value is calculated by multiplying the par value by the coupon rate. In our example, $70 is the coupon payment which is calculated by multiplying .07 by the par value ($1000 * .07 = $70).
Calculate the YTM and years until maturity. Based on our example, the equation is 70(1 + r)^1 + 70(1 + r)^2 + 70(1 + r)^3 + 70(1 + r)^4 + 1000(1 + r)^4 = 950, so you can solve for r. The answer is 4.25 percent, assuming payments are made on a bi-annual basis for 4 years. While you can solve this through trial and error, the best way to solve YTM calculations is by using a YTM calculator. Input the variables as they are defined here. See Resources for an example.
Interpret the results. A bond paying two coupon payments per year at a 7 percent rate of interest and a market value of $950 with a 4-year maturity has a yield to maturity of 4.25 percent.
Note: Years to maturity is a given, as companies have set offerings with maturity dates; that is, there is no flexibility outside of what's currently offered. However, you might still want to calculate under different scenarios. This is the beauty of the calculator.
- Note: Years to maturity is a given, as companies have set offerings with maturity dates; that is, there is no flexibility outside of what's currently offered. However, you might still want to calculate under different scenarios. This is the beauty of the calculator.
Working as a full-time freelance writer/editor for the past two years, Bradley James Bryant has over 1500 publications on eHow, LIVESTRONG.com and other sites. She has worked for JPMorganChase, SunTrust Investment Bank, Intel Corporation and Harvard University. Bryant has a Master of Business Administration with a concentration in finance from Florida A&M University.