Definition of Yield to Maturity
Yield to maturity is the total return that will be earned by someone who purchases a bond and holds it until its maturity date. The yield to maturity might also be referred to as:
- Internal rate of return
- Market interest rate at the time that the bond was purchased by the investor
The yield to maturity is expressed as an annual percentage rate.
Example of Yield to Maturity
Assume that a 5% $100,000 bond will mature in 5 years and will pay interest each June 1 and December 1. This means that the bondholder will be paid interest of $2,500 every six months until the bond matures.
If the current market interest rate for this type of bond is 6%, the current market value of the 5% bond will be less than $100,000. Assume that the market value for this bond is only $95,735. (The market value is computed by discounting 1) the $2,500 of interest that will be received every six months for 5 years to its present value and 2) the $100,000 maturity amount that will be received at the end of 5 years. These cash amounts are discounted by the market interest rate of 3% per semiannual period for 10 semiannnual periods.)
You can also view the yield to maturity of this bond as the following two components:
- the current yield of slightly more than 5.2% because the investor is receiving cash of $2,500 every six months ($5,000 per year) on an investment of only $95,735.
- a gain of $4,265 because the investor bought the bond for $95,735 but will receive $100,000 when the bond matures.