When it comes to bonds, there are a lot of numbers and terms to know. Twoof the most important concepts for bond investors are yield to maturity(YTM) and current yield. Here's a look at the key difference betweenthese two measures.
Yield to maturity isthe rate of return an investor will earn if a bond is held until itmatures and all coupon and principal payments are made on time. Tocalculate YTM, you need to know the bond's price, coupon rate, time tomaturity, and interest payments per year. The YTM formula is:
YTM = [(C/P) (1/n)] - [(1/n) (1 + C/P)]
For example, let's say you buy a bond for $1,000 thathas a 6% coupon rate and matures in 10 years. The bond pays interestsemiannually, so there are 20 coupon payments over the 10-year life ofthe bond. The YTM formula would be:
YTM= [(60/1000) (1/2)] - [(1/2) (1 + 60/1000)]
Current yield is a bond'sannual interest payment divided by its current market price. UnlikeYTM, current yield doesn't take into account the bond's price appreciationor depreciation, coupon payments, or time to maturity. The current yieldformula is:
Current Yield = AnnualInterest Payment / Current Market Price
For example, let's sayyou buy a bond for $1,000 that has a 6% coupon rate and pays interestsemiannually. The bond's current yield would be:
Current Yield =60 / 1,000
Which equals 6%.
Yield tomaturity is the most comprehensive measure of a bond's return. It takesinto account the bond's price appreciation or depreciation, couponpayments, and time to maturity. Current yield is a simpler measure thatonly looks at a bond's annual interest payment and current market price.