What is Yield to Maturity? Definition, Formula, and Example
Yield to maturity is the total annualized return an investor earns by holding a bond until maturity, assuming all coupons are reinvested at the same rate and the issuer does not default.
What is Yield to Maturity?
Yield to maturity (YTM) is the internal rate of return of a bond if held to maturity. It is the single discount rate that equates the present value of all future cash flows, coupons plus the final principal repayment, to the bond's current market price. YTM is the standard way bonds are quoted and compared, because it collapses coupon rate, price, and time into one number. A bond trading below par has a YTM above its coupon rate; a bond above par has a YTM below its coupon. For traders, YTM is the bond equivalent of an earnings yield: the price you pay today implies the return you lock in, assuming the issuer pays.
How Yield to Maturity is Calculated
YTM solves this equation for y:
Price = sum of [C / (1+y)^t] for each period t, plus Face / (1+y)^N
where C is the periodic coupon payment, N is the number of periods to maturity, and Face is the par value, usually 1,000. There is no closed-form solution; YTM is found by iteration. A usable approximation:
YTM approx [C + (Face - Price) / N] / [(Face + Price) / 2]
YTM moves inversely to price. The sensitivity of price to a change in yield is measured by bond duration, and the curvature of that relationship is convexity. For callable bonds, yield to call replaces YTM, computed to the call date and call price.
Worked Example
Take a hypothetical 10-year corporate bond issued by a company like F: face value 1,000, annual coupon of 60 (6% coupon rate), currently trading at 920 with 10 years to maturity. Approximation: numerator = 60 + (1000 - 920)/10 = 68; denominator = (1000 + 920)/2 = 960; YTM approx 68/960 = 7.08%. Iterating the exact formula gives about 7.16%. The market is demanding roughly 7.2% to hold this credit to maturity, versus the 6% coupon, because the price has fallen to 92 cents on the dollar. Now compare a Treasury bill at 5.3%: the roughly 190 basis point gap is the credit spread, the market's price for Ford's default risk. If that spread widens to 300 bps, the bond's price drops further and YTM rises.
When Traders Use It
YTM is the comparison currency of fixed income. Credit traders screen entire bond universes by YTM versus duration-matched Treasuries to find spread anomalies. Equity investors use it in reverse: when a company's bonds yield 12% to maturity, the bond market is pricing real distress, and the equity is usually mispriced if it does not reflect that. YTM also anchors relative value across the capital structure: convertible bonds, preferreds, and common equity can be ranked by implied return. Macro traders track the aggregate YTM of high-yield indices as a recession signal, since junk yields above 10% have historically coincided with credit stress. For the equity side of the picture, the filings behind any issuer are on the filings feed.
Limitations and Common Misconceptions
YTM assumes reinvestment of every coupon at the YTM itself, which never happens in a changing rate environment; realized return will differ. It assumes no default, which for a 12% high-yield bond is a heroic assumption, so YTM on distressed debt is a ceiling, not an expectation. It ignores call provisions, so a callable bond's quoted YTM may never be realized. It is a nominal number with no inflation adjustment. Finally, YTM says nothing about price path: two bonds with identical YTMs but different durations carry very different mark-to-market risk, which is why duration and YTM must be read together.