Yield to Maturity (YTM)
The yearly return a bond pays if you buy it at today's price and hold it to the end, and why it, not the coupon, is the number to compare bonds by.
Key idea
Yield to maturity is the yearly return you lock in by buying a bond at today's price and holding it until it's repaid. It counts both the coupons and the gain or loss between the price you pay and the face value you get back. That's why it, not the coupon, is the number to compare bonds by.
What it is
A bond's coupon tells you what it pays each year as a share of its face value. But you rarely buy a bond at exactly its face value. The yield to maturity, or YTM, is the yearly return you earn if you buy at today's price, collect every coupon and get the face value back at the end. It counts both the coupons and the gain or loss between the price you pay and the face value you receive.
Technically, it's the interest rate at which all the bond's future payments, discounted back to today, add up to its current price. You don't need to calculate it yourself: banks and brokers quote it next to the price. What matters is what it tells you.
Same bond, three prices
Take the same bond as in the Bond article: CHF 1,000 face value, a 4% coupon, so CHF 40 a year, and 10 years to maturity. Here's what you earn at three different purchase prices:
| Price Paid | Gain or Loss at Maturity | Current Yield | YTM |
|---|---|---|---|
| 922.78 | +77.22 | 4.33% | 5.00% |
| 1,000.00 | 0.00 | 4.00% | 4.00% |
| 1,085.30 | −85.30 | 3.69% | 3.00% |
All three buyers receive the same CHF 400 in coupons over ten years. What differs is the end. Buying at 922.78, you get 77.22 more back than you paid, for a total profit of 477.22. Buying at 1,085.30, you get 85.30 less back, and the profit shrinks to 314.70. The current yield, the coupon divided by the price, only captures part of this. The yield to maturity captures all of it.
Reading a bond's yield
Three things the yield to maturity tells you that the coupon doesn't:
Coupon vs yield
The coupon is fixed when the bond is issued. The yield moves with the price, every trading day.
Price matters
Below face value, the yield is higher than the coupon. Above it, lower. At face value, the two are equal.
Comparing bonds
Different coupons and prices, one comparable number. Compare similar bonds by their yield, not their coupon.
The honest caveat
Yield to maturity rests on assumptions. It assumes the issuer pays every coupon and the face value in full and on time, so for a weak issuer, a high yield is partly a warning, not a promise. And it assumes you hold to maturity: sell early, and you get whatever the market pays that day.
It also assumes every coupon is reinvested at the same rate. Buy the bond at 922.78 for a 5% yield and reinvest the coupons at 5%, and you end with 1,503.12 after ten years. Reinvest them at only 3% and you end with 1,458.56, a return of 4.68% a year instead of 5%.
Swiss note
For most of 2015 to 2021, 10-year bonds of the Swiss Confederation had a negative yield to maturity. Buyers paid so far above face value that all the coupons plus the repayment added up to less than the price: a small loss, locked in on the day of purchase. They accepted it for the safety of lending to the Confederation in francs.
Key takeaways
- —YTM is the yearly return if you buy at today's price, collect every coupon and get the face value back.
- —Bought below face value, a bond yields more than its coupon; bought above, it yields less.
- —Compare bonds by their yield to maturity, not their coupon.
- —YTM assumes every payment arrives on time and coupons are reinvested at the same rate.