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a bond and YTM.
The Yield to maturity (YTM) or redemption yield of a bond or other fixed-interest security, such as gilts, is the internal rate of return (IRR, overall interest rate) earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity, and that all coupon and principal payments will be made on schedule. Contrary to popular belief, including concepts often cited in advanced financial literature, Yield to maturity does NOT depend upon a reinvestment of coupon payments. Yield to maturity, rather, is simply the discount rate at which the sum of all future cash flows from the bond (coupons and principal) are equal to the price of the bond. The YTM is often given in terms of Annual Percentage Rate (A.P.R.), but more usually market convention is followed: in a number of major markets the convention is to quote yields semi-annually (see compound interest: thus, for example, an annual effective yield of 10.25% would be quoted as 5.00%, because 1.05 x 1.05 = 1.1025).
The yield is usually quoted without making any allowance for tax paid by the investor on the return, and is then known as "gross redemption yield". It also does not make any allowance for the dealing costs incurred by the purchaser (or seller).
· If the yield to maturity for a bond is less than the bond's coupon rate, then the (clean) market value of the bond is greater than the par value (and vice versa).
· If a bond's coupon rate is less than its YTM, then the bond is selling at a discount.
· If a bond's coupon rate is more than its YTM, then the bond is selling at a premium.
· If a bond's coupon rate is equal to its YTM, then the bond is selling at par.
Market price of a bond
Par Value
The par value of a bond, also known as its face value, represents the amount to be paid back to the bondholder at the bond's maturity date. The most common bond par value is $1,000.
Present Value Tables
Present value tables (see Resources) compute the present value factors based on a time period and an interest rate. To use the table, find the interest rate the bond pays per period on the top of the table, then find the number of times the bond will pay interest on the table's left side. Then find the number that matches up with the time and the interest. Say you have a bond that pays interest semiannually and has a par value of $100,000. The current interest rate on the bond is 6 percent and the bond matures in five years. The interest rate needs to be divided by two, and the years need to be doubled to account for two payments in one year. Therefore, look up 3 percent and 10 years on the present value of $1 table, where the factor is 0.7441. Then go to the present value of an annuity table, where 3 percent and 10 years would mean a present value of an annuity factor of 8.5302.
Interest Payment
Most bonds will pay interest semiannually. To compute the interest payment, multiply the par value of the bond by the interest rate per payment. In the example, if the bond's stated annual interest rate is 6 percent, then 3 percent times $100,000 equals semiannual interest payments of $3,000.
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