Yield to maturity is the internal rate of return on a bond held from purchase to maturity. It is the single discount rate that makes the present value of all the bond's remaining cash flows, the coupons plus the face value paid at maturity, equal to the price paid today. Because it accounts for the purchase price and the pull toward face value at maturity, and not just the stated interest, it is the most complete of the several numbers a bond's return can be quoted as.
Yield to Maturity (YTM)
Yield to maturity is the single annualized return a bond investor earns if they buy at today's price and hold the bond until it matures, counting every coupon and the gain or loss between the purchase price and the face value repaid at the end.
Last reviewed by Steven Fox, CFP®, EA
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Quick Summary
- Yield to maturity folds three things into one rate, combining the price you pay, the coupons you collect, and the difference between that price and the face value returned at maturity.
- When people say "the yield" on a bond, they almost always mean yield to maturity.
- Price and yield move in opposite directions, so a bond bought below face value has a yield to maturity above its coupon rate, and one bought above face value has a yield below it.
- The figure assumes every coupon is reinvested at that same yield, an assumption the actual future rarely honors.
Definition
Advanced Explanation
A bond promises a fixed stream: periodic coupons and the return of face value on a set date. Its market price, though, floats with prevailing interest rates. Yield to maturity is the rate that reconciles the two. If a bond trades below its face value, the buyer collects the coupons and also a gain when the face value is repaid, so the yield to maturity exceeds the coupon rate. If it trades above face value, the buyer absorbs a loss to maturity that drags the yield below the coupon. The single most important caveat is buried inside the math. The internal rate of return treats every coupon as if it were reinvested at the yield to maturity itself. If rates fall after purchase, the coupons get reinvested at less than that rate and the return actually realized falls short of the quoted yield. That fragility is the subject of reinvestment risk, and it is why two bonds with identical yields to maturity can deliver different realized returns. Yield to maturity is a projection made under one assumption, not a guaranteed outcome. It also assumes the issuer never defaults and the bond is not called early; a callable bond is more honestly measured by its yield to worst.
Used in a Sentence
“The bond's coupon was 4 percent, but because Priya bought it at a discount its yield to maturity worked out closer to 5 percent.”
How It Works
Yield to maturity is found by solving for the rate that equates a bond's price with the present value of its cash flows, which requires iteration rather than a single division. A widely used approximation gets close enough to see the logic.
A hypothetical example. A bond has a $1,000 face value, a 5 percent coupon ($50 a year), five years left to maturity, and trades today at $960. The approximation adds the annual coupon to the annualized price gain and divides by the average of price and face value:
- Annualized gain to maturity: ($1,000 − $960) ÷ 5 years = $8 a year.
- Numerator: $50 coupon + $8 = $58.
- Denominator: ($1,000 + $960) ÷ 2 = $980.
- Approximate yield to maturity: $58 ÷ $980 = about 5.9 percent.
The yield sits above the 5 percent coupon precisely because the bond was bought below face value. Solving exactly rather than by approximation lands in the same neighborhood, near 5.9 percent. Had the same bond cost $1,040, the loss to maturity would pull the yield below 5 percent.
Pros and Cons
Pros
- Captures total return over the holding period, not just the stated coupon, so it compares bonds with different prices and maturities on one scale.
- It is the figure quoted and understood across the market, which makes it the common language of bond pricing.
- Moves inversely to price, giving a clear read on whether a bond is trading at a discount or a premium.
Cons
- Assumes every coupon is reinvested at the same yield, which almost never holds and can leave the realized return below the quoted one.
- Assumes the bond is held to maturity and the issuer never defaults; a sale before maturity or a default breaks the calculation.
- For a callable bond it can overstate the return, since the issuer may redeem the bond early when doing so favors the issuer.
People Also Asked
Answers to the most frequently asked questions.
What is the difference between yield to maturity and the coupon rate?
The coupon rate is the fixed interest the bond pays each year as a percentage of its face value, and it never changes. Yield to maturity is the total annualized return based on what you actually pay for the bond, which includes the coupons plus any gain or loss to face value at maturity. They are equal only when the bond is bought at exactly its face value.
Why does yield to maturity rise when a bond's price falls?
The coupons and the face value are fixed, so paying less for that same stream means earning more on the money invested. A lower price also means a larger gain when the face value is repaid at maturity. Both effects push the yield up, which is why bond prices and yields always move in opposite directions.
Is yield to maturity a guaranteed return?
No. It is a projection that assumes you hold the bond to maturity, the issuer makes every payment, and you reinvest each coupon at the same yield. If interest rates fall and you reinvest coupons at lower rates, or if you sell early, your actual return can differ from the quoted yield to maturity.
What does "the yield" on a bond usually mean?
In most contexts it means yield to maturity. A bond's return can be stated several ways, including current yield and yield to call, but yield to maturity is the default because it reflects the full return of holding the bond to the end. The broader family of measures is covered under bond yield.
Related Terms
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