Learn How to Calculate Bond Yield to Maturity YTM

Have you ever wonder what is the yield earned by your bond? There are mainly 3 different ways to calculate bond yield: Coupon rate, current yield and yield to maturity (YTM). YTM is the overall return of a bond which takes all coupons and principle into account when it is held until maturity. The final rate derived is the  Internal Rate of Return (IRR).

 

How to Calculate Bond Yield to Maturity?

 

Presume that you are buying a bond with the par value of $1,000 at the price of $950. The maturity period of the bond is 10 years. Within this 10 years, your coupon or interest rate is 5% per annum.

 

To make the process of calculation easier, we assume that:

  • at the end of 10 years, you get back the face value of $1,000

  • the bond issuer never default on payment and the 5% coupon rate has been paid annually

  • all the coupons are withdrawn annually

Let's see what are the earnings you would get after the period of 10 years:

  • you earn $50 from the difference of par value and the market value of your bond ($1,000-$950)

  • you earn total coupon of $500 ($1,000 x 5% x 10)

  • there are 3 ways to calculate YTM:

  • 1st, you may use cash flow function in the financial calculator (HP10BII) to calculate the YTM

  • Initial, press "-950" "CFj"

  • Year1, key in "50" "CFj"

  • Year2-9, key in "50" "CFj" "8" "Shift" "Nj"

  • Year10, key in "1050" "CFj"

  • Press "Shift" "IRR/YR"

  • Then you should get the result of 5.67, which indicates YTM=5.67%

  • 2nd, you can use Microsoft Excel to help you

  • You need 11 columns (say A1 to A11) to key in your figures

  • initial column A1, key in your capital, which is "-950"

  • year 1-9 column (A2-A10), key in your returns, which is "50"

  • year 10 column A11, key in your return, which is "1050"

  • then at any column below, key in "=IRR(A1:A11)"

  • press enter, you should get the result of 5.67, which indicates YTM=5.67%

  • 3rd, you can use any YTM calculator online to assist you.

It is fun to learn how to calculate bond yield to maturity. You will have better understanding of how it works for you.

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