Here is a useful fact. Two bonds with the same coupon can give very different returns if their prices are different. Yield to maturity shows the total return you may earn if you buy a bond today and hold it till it pays back your principal. Many investors in bonds use YTM to compare choices in a fair way.

What is yield to maturity

Yield to maturity or YTM is the single rate that makes the present value of all future cash flows equal to today’s price. Cash flows include every coupon you receive and the principal you get at maturity. In short YTM is the true annual return if all payments come on time and you hold the bond to the end. It helps you compare bonds with different coupons and different prices.

Why YTM matters

Price moves and coupon size and time to maturity all affect your return. YTM puts all of this into one clear number. When bonds trade below face value YTM is higher than the coupon. When bonds trade above face value YTM is lower than the coupon. So YTM tells you what you really earn not just what the coupon says.

The YTM formula in simple words

There is a long math way that a calculator or spreadsheet solves. For a quick estimate many investors use this easy formula

YTM is approximately equal to
annual coupon plus face value minus price divided by years to maturity
all divided by
average of face value and price

In symbols

YTM ≈ [C plus (F minus P) divided by n] divided by [(F plus P) divided by 2]

Here C is the annual coupon. F is face value. P is the clean price you pay. n is the number of years left.

Step by step example

Say a bond has face value 1000 and coupon 8 percent paid once a year. You buy it at 950 and it will mature in 5 years.

Step 1. Work out C. It is 8 percent of 1000 which is 80.
Step 2. Find the annual gain from the price pull to face value. F minus P is 1000 minus 950 which is 50. Divide by n which is 5. You get 10.
Step 3. Add Step 1 and Step 2. That is 80 plus 10 which is 90.
Step 4. Find the average of F and P. That is the average of 1000 and 950 which is 975.
Step 5. Divide Step 3 by Step 4. So 90 divided by 975 is about 9.23 percent.

So the YTM is roughly 9.23 percent. This is higher than the 8 percent coupon because you bought below face value. Such clear steps make bonds easier to compare.

What changes YTM

If price rises YTM falls. If price falls YTM rises. A longer time to maturity increases the effect of price changes. Higher coupons give more cash early and that can also change YTM. This is why bonds react to interest rate moves in the market.

Common mistakes

Do not mix up coupon with YTM. Coupon is fixed on face value. YTM depends on price and time and reinvestment at the same rate. Also check if the bond pays semiannual coupons because then the exact math needs a small tweak.

Final words

YTM turns a complex stream of cash into one simple rate. Use it to compare bonds and to judge fair value. With a little practice you will read prices and coupons with confidence and make smarter choices in bonds.