What is yield to maturity (YTM)?

What is yield to maturity (YTM)?

• A. The rate of return earned if the bond is sold before maturity.
• B. The internal rate of return expected if the bond is held to maturity given current price, coupon, and time to maturity.
• C. The coupon rate adjusted for inflation.
• D. The yield required by new buyers in the market.

Answer: (B)

Yield to maturity is the rate of return you would earn if you held the bond all the way to its maturity, based on the bond’s current price, the coupon payments it will pay, and the time left until it matures. It’s effectively the internal rate of return on the bond’s cash flows—the coupons you receive plus the repayment of principal—discounted back to today. This definition assumes you reinvest the coupons at the same rate (the YTM). The other ideas don’t fit as well. If you sold the bond before it matures, you’d face a different return depending on the sale price, not the YTM. The coupon rate adjusted for inflation reflects a real yield, not the nominal yield to maturity. And the yield required by new buyers describes the market price for a new issue today, not the return you’d get by holding this specific bond to maturity.

Yield to maturity is the rate of return you would earn if you held the bond all the way to its maturity, based on the bond’s current price, the coupon payments it will pay, and the time left until it matures. It’s effectively the internal rate of return on the bond’s cash flows—the coupons you receive plus the repayment of principal—discounted back to today. This definition assumes you reinvest the coupons at the same rate (the YTM).

The other ideas don’t fit as well. If you sold the bond before it matures, you’d face a different return depending on the sale price, not the YTM. The coupon rate adjusted for inflation reflects a real yield, not the nominal yield to maturity. And the yield required by new buyers describes the market price for a new issue today, not the return you’d get by holding this specific bond to maturity.