Watch
Watching this resources will notify you when proposed changes or new versions are created so you can keep track of improvements that have been made.
Favorite
Favoriting this resource allows you to save it in the “My Resources” tab of your account. There, you can easily access this resource later when you’re ready to customize it or assign it to your students.
Calculating the Yield to Maturity using the Bond Price
The yield to maturity is the discount rate that returns the bond's market price: YTM = [(Face value/Bond price)1/Time period]1.
Learning Objective

Calculate a bond's yield to maturity
Key Points

To achieve a return equal to YTM (i.e., where it is the required return on the bond), the bond owner must buy the bond at price P0, hold the bond until maturity, and redeem the bond at par.

If a bond's coupon rate is less than its YTM, then the bond is selling at a discount. If a bond's coupon rate is more than its YTM, then the bond is selling at a premium. If a bond's coupon rate is equal to its YTM, then the bond is selling at par.

Formula for yield to maturity: Yield to maturity(YTM) = [(Face value/Bond price)1/Time period]1.
Term

discount rate
The interest rate used to discount future cash flows of a financial instrument; the annual interest rate used to decrease the amounts of future cash flow to yield their present value.
Full Text
YTM
The yield to maturity is the discount rate which returns the market price of the bond. YTM is the internal rate of return of an investment in the bond made at the observed price.
To achieve a return equal to YTM (i.e., where it is the required return on the bond), the bond owner must buy the bond at price P_{0}, hold the bond until maturity, and redeem the bond at par.
If the yield to maturity for a bond is less than the bond's coupon rate, then the (clean) market value of the bond is greater than the par value (and vice versa). If a bond's coupon rate is less than its YTM, then the bond is selling at a discount. If a bond's coupon rate is more than its YTM, then the bond is selling at a premium. If a bond's coupon rate is equal to its YTM, then the bond is selling at par.
Calculating YTM
Formula for yield to maturity: Yield to maturity(YTM) = [(Face value/Bond price)^{1/Time period}]1
As can be seen from the formula, the yield to maturity and bond price are inversely correlated.
Consider a 30year, zerocoupon bond with a face value of $100. If the bond is priced at an annual YTM of 10%, it will cost $5.73 today (the present value of this cash flow, 100/(1.1)30 = 5.73). Over the coming 30 years, the price will advance to $100, and the annualized return will be 10%.
What happens in the meantime? Suppose that over the first 10 years of the holding period, interest rates decline, and the yieldtomaturity on the bond falls to 7%. With 20 years remaining to maturity, the price of the bond will be 100/1.0720, or $25.84. Even though the yieldtomaturity for the remaining life of the bond is just 7%, and the yieldtomaturity bargained for when the bond was purchased was only 10%, the return earned over the first 10 years is 16.25%. This can be found by evaluating (1+i) from the equation (1+i)10 = (25.842/5.731), giving 1.1625.
Over the remaining 20 years of the bond, the annual rate earned is not 16.25%, but rather 7%. This can be found by evaluating (1+i) from the equation (1+i)20 = 100/25.84, giving 1.07. Over the entire 30 year holding period, the original $5.73 invested increased to $100, so 10% per annum was earned, irrespective of any interest rate changes in between.
Assign just this concept or entire chapters to your class for free.
Key Term Reference
 Interest
 Appears in this related concepts: Times Interest Earned Ratio, Interest Compounded Continuously, and Tax Considerations
 Yield to maturity
 Appears in this related concepts: Reinvestment Risk, Duration, and Other Features
 bond
 Appears in this related concepts: Reporting Current Liabilities, Introduction to Bonding, and Comparing Common Stock, Preferred Stock, and Debt
 cash flow
 Appears in this related concepts: Defining the Cash Flow Cycle, The Imperative of Liquidity, and Interpreting Overall Cash Flow
 discount
 Appears in this related concepts: The Discount Rate, Par Value at Maturity, and Present Value, Multiple Flows
 interest rate
 Appears in this related concepts: SinglePeriod Investment, Why is it Important?, and The Equilibrium Interest Rate
 investment
 Appears in this related concepts: Functions of Corporate Finance, Defining Finance, and Agencies
 market value
 Appears in this related concepts: LowerofCostorMarket, Maximizing Value without Harming Stakeholders, and Maximizing Shareholder and Market Value
 maturity
 Appears in this related concepts: Amortized Cost Method, Shareholders Conflicts with Bondholders, and Accounting for Interest Earned and Principal at Maturity
 par
 Appears in this related concepts: Characteristics of Bonds, Call Provisions, and Accounting for Preferred Stock
 par value
 Appears in this related concepts: Bonds Issued at Par Value, Accounting for Sale of Stock, and Equity Finance
 period
 Appears in this related concepts: Atomic Size, Annuities, and Frequency of Sound Waves
 premium
 Appears in this related concepts: The Term Structure, Redeeming Before Maturity, and Health Care Reform
 present value
 Appears in this related concepts: The Relationship Between Present and Future Value, Capital Leases versus Operating Leases, and Present Value and the Time Value of Money
 required return
 Appears in this related concepts: Clientele, Differences Between Required Return and the Cost of Capital, and The Capital Asset Pricing Model
 return
 Appears in this related concepts: Dollar Returns, Finance, Economics, and Accounting: Differences and Commonalities, and Disadvantages of the Payback Method
 yield
 Appears in this related concepts: Bonds Payable and Interest Expense, Stock Warrants, and Calculating the Yield of an Annuity
Sources
Boundless vets and curates highquality, openly licensed content from around the Internet. This particular resource used the following sources:
Cite This Source
Source: Boundless. “Calculating the Yield to Maturity using the Bond Price.” Boundless Finance. Boundless, 02 Jul. 2014. Retrieved 20 Mar. 2015 from https://www.boundless.com/finance/textbooks/boundlessfinancetextbook/bondvaluation6/valuingbonds68/calculatingtheyieldtomaturityusingthebondprice3101033/