Lesson 2 of 6 · All lessons in this module
- Pricing a bond with a market discount rateVideo lesson
- Yield-to-maturity: the bond's internal rate of returnVideo lesson
- Between coupon dates: accrued interest, flat and full priceVideo lesson
- How coupon, maturity and yield drive bond pricesVideo lesson
- Matrix pricing for illiquid and new bondsVideo lesson
- Integrated cases: building and reading a pricing matrix
Lesson 2 of 6 · 12 min
Yield-to-maturity: the bond's internal rate of return
The yield-to-maturity is the single discount rate that makes the PV of a bond's cash flows equal its observed price, and an investor earns it only under three strict conditions.
In short
- Yield-to-maturity (YTM) = the internal rate of return on the bond's cash flows, given its price.
- It is an implied (observed) single market discount rate; market participants often just call it the yield.
- An investor earns the YTM only if they (1) hold to maturity, (2) receive every coupon and the principal on time, and (3) reinvest every coupon at the YTM.
- Because it assumes no default, the YTM is a promised yield.
- Solve for the periodic IRR, then annualize: × 2 for semiannual bonds.
- YTMs can be zero or negative: a zero-coupon bond priced above par has a negative YTM.
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