key term - Yield to Maturity

Definition

Yield to maturity (YTM) is the total return expected on a bond if the bond is held until it matures. It represents the annual rate of return earned by an investor who buys a bond at the current market price and holds it until the bond's maturity date. YTM is a key concept for households when supplying financial capital through bond investments.

5 Must Know Facts For Your Next Test

1. Yield to maturity accounts for the bond's coupon payments, the bond's purchase price, and the bond's face value at maturity.
2. YTM is calculated based on the time remaining until the bond's maturity date and the bond's current market price.
3. As bond prices rise, the yield to maturity decreases, and as bond prices fall, the yield to maturity increases.
4. YTM is used by investors to compare the potential returns of different bond investments with varying maturities and coupon rates.
5. Households often consider YTM when supplying financial capital through bond investments, as it helps them evaluate the overall return on their investment.

Review Questions

• Explain how the yield to maturity of a bond is calculated and the factors that influence it.
  • The yield to maturity of a bond is calculated based on the bond's current market price, the bond's remaining time to maturity, and the bond's coupon payments. Factors that influence the yield to maturity include the prevailing interest rates in the market, the bond's credit quality, and the overall demand for the bond. As bond prices rise, the yield to maturity decreases, and as bond prices fall, the yield to maturity increases. Investors use the yield to maturity to evaluate the potential return on a bond investment and compare it to other investment options.
• Describe the role of yield to maturity in the context of how households supply financial capital.
  • When households supply financial capital through bond investments, the yield to maturity is a crucial consideration. Yield to maturity represents the total return that a household can expect to receive if they hold a bond until its maturity date. This information helps households evaluate the potential returns on their bond investments and make informed decisions about how to allocate their financial capital. By understanding the yield to maturity, households can compare the relative attractiveness of different bond investments and determine which ones best align with their investment goals and risk preferences.
• Analyze how changes in market interest rates can affect the yield to maturity of a bond and the implications for households supplying financial capital.
  • When market interest rates rise, the prices of existing bonds fall, causing their yield to maturity to increase. Conversely, when market interest rates fall, the prices of existing bonds rise, and their yield to maturity decreases. These changes in yield to maturity have important implications for households supplying financial capital through bond investments. Households must consider how fluctuations in interest rates can impact the returns they receive on their bond investments, and they may need to adjust their investment strategies accordingly. For example, if interest rates are expected to rise, households may choose to invest in shorter-term bonds to minimize the impact on their portfolio's yield to maturity. Understanding the relationship between interest rates, bond prices, and yield to maturity is crucial for households to make informed decisions when supplying financial capital.

Related terms

Coupon Rate:

The fixed interest rate paid on a bond, expressed as a percentage of the bond's face value.

Bond Price: The current market value of a bond, which fluctuates based on factors such as interest rates and the bond's creditworthiness.

Maturity Date: The date on which the bond issuer must repay the bond's face value to the bondholder.