Yield to Maturity Is a Cash-Flow Rate
Current yield compares annual coupon income with market price. Yield to maturity solves for the discount rate that equates the entered price with the bond's remaining coupon and principal cash flows.
Realized return can differ from YTM because of reinvestment rates, default or call risk, taxes, transaction costs and sale price if the bond is not held to maturity.
Bond yield changes when market price changes even though the coupon payment may stay fixed. Buying below face value can increase the return to maturity because you receive coupon income and, if the bond pays as promised, the difference between purchase price and face value at maturity. Yield-to-maturity also assumes the bond is held and contractual payments are made. Credit risk, calls, taxes and reinvestment of coupons can make an investor's realized return different from the calculated yield.
Frequently Asked Questions
Is YTM the return I am guaranteed to earn?
No. YTM is a model based on the entered cash flows and assumptions. Realized return can differ materially.
Why do bond prices and yields usually move in opposite directions?
The bond's promised cash flows are largely fixed. When the market price falls, those same payments represent a higher return relative to the price paid; when price rises, the opposite occurs.
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