Yield to maturity (YTM) is the total annualized return an investor would earn if they purchased a bond at the current price, held it to maturity, and reinvested all coupon payments at the YTM rate.
YTM = the bond's internal rate of return (IRR).
Key relationships:
| Bond price vs. par | Relationship to coupon rate | |---|---| | Price < par (discount bond) | YTM > coupon rate | | Price = par | YTM = coupon rate | | Price > par (premium bond) | YTM < coupon rate |
Why: When you buy a discount bond, you receive the coupon PLUS a capital gain at maturity (buying at $950, receiving $1,000). Both contribute to your total return → YTM > coupon.
Approximate YTM formula: > YTM ≈ [Annual Coupon + (Par − Price)/Years to Maturity] ÷ [(Par + Price)/2]
Example: 5% coupon bond, 10 years to maturity, price = $900, par = $1,000. - Annual coupon = $50; price discount = $100/10 years = $10/year. - Average price = ($1,000 + $900)/2 = $950. - Approximate YTM = ($50 + $10) ÷ $950 = 6.32%.
Assumptions: YTM assumes coupons are reinvested at the YTM rate (reinvestment risk) and that the bond is held to maturity (no default, no sale).
> Exam tip: YTM is the most important bond yield measure. Know the inverse relationship: price up → YTM down; price down → YTM up. Heavily tested on Series 7, Series 65/66, and CFP®.