Yield to Maturity (YTM)

What yield to maturity actually measures

A bond is a stream of known cash flows: a coupon every six months, then the face value at maturity. Yield to maturity is the one discount rate that makes all of those future dollars add up to what the bond costs today. Put differently, it is the annual return baked into the current price, assuming you hold to maturity and reinvest coupons along the way.

That makes YTM the number that lets you compare bonds fairly. A 2% coupon bond bought at a deep discount and a 5% coupon bond bought at a premium might look completely different on the surface, but their YTMs put them on the same footing. When a dealer or a news headline quotes a bond's "yield", YTM is almost always the number they mean.

There is no clean algebraic formula for YTM. It is found by iteration, trying rates until the discounted cash flows match the price, which is what bond calculators and trading systems do behind the scenes.

The price and yield see-saw

Price and yield move in opposite directions, always. When a bond's price falls, its fixed cash flows cost less to buy, so the return on your money, the YTM, rises. When the price climbs, the YTM falls.

The coupon rate is the pivot point. A bond trading below par (under its face value) has a YTM above its coupon rate: you collect the coupons and pick up a capital gain at maturity. A bond trading above par has a YTM below its coupon rate: the rich coupons are partly cancelled by the guaranteed loss from paying, say, $1,050 for something that repays $1,000. A bond at exactly par has a YTM equal to its coupon.

YTM vs. current yield vs. coupon rate

These three numbers get mixed up constantly, and they are only equal when a bond trades exactly at par. They answer different questions:

• A $1,000 face bond with a 4% coupon bought at $960 has a coupon rate of 4%, a current yield of about 4.17% ($40 divided by $960), and a YTM higher still, because YTM also counts the $40 gain you collect at maturity.
• Current yield always sits between the coupon rate and the YTM for a discount or premium bond, which makes it a tempting but incomplete shortcut.

Canadian bond conventions

Canadian bonds pay semi-annual coupons, and quoted yields follow that rhythm: a quoted YTM of 4.9% means 2.45% per six-month period, compounded twice a year. This semi-annual compounding convention matches how Government of Canada and provincial bonds are quoted by dealers.

Day counting follows the Actual/Actual (Canada) convention, which governs how partial coupon periods and accrued interest are measured when a bond trades between coupon dates. Our Bond Calculator uses these same conventions, semi-annual compounding and Actual/Actual (Canada), so the YTM it reports matches the yields you see on dealer quotes rather than an annualized approximation.

What YTM assumes, and when it breaks

YTM is an honest number only under its own assumptions. First, it assumes you hold to maturity. Sell early and your realized return depends on the price that day, which can be far from what YTM promised. Second, it assumes every coupon is reinvested at the YTM itself. If rates fall after you buy, your coupons reinvest at lower rates and your realized return slips below the quoted YTM, a problem known as reinvestment risk.

Callable bonds add another wrinkle. If the issuer can redeem the bond early, the cash flows YTM relies on may never arrive. For bonds trading above par especially, investors look at yield to call, the same calculation run to the call date and call price, and often quote the lower of the two (yield to worst).