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Finance Glossary

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Yield To Maturity

Definition:

This is the yield that a bondholder will receive by holding the bond until it matures. This assumes that the interest payments are all reinvested, so yield to maturity will change over time as the reinvestment rate fluctuates.

Example

You buy a bond for $1,000 (i.e. at Par) which has a face yield of 6%. That's it. Simple. It's yield to maturity is 6%. 

But it's not. Not really, anyway. 

Why? Because when YTMs are calculated they assume that the 6% is REINVESTED and returns that 6% face value. But, in fact, that's usually not what happens. You get your 30 bucks twice a year on the grand you put down with your broker and... you spend it. On whatever. But you spend it—oh, and you spend it after you are taxed on it. So it's...less. 

What happens if you pay a premium for your bond? Like, you've paid $1,100 for a bond yielding 6%—your YTM will be LESS than 6% because you've paid a premium—but the calculated rate would be as if you reinvested the money at 6% so that YTM number usually overstates the real value you'll derive from that bond. 

Might not seem like much...until you're retired and living on a budget and need every penny to buy toys for your bratty grandkids at Christmas. In this case, note that the yield is in the low 5%s which means that the prevailing rates are lower than they were when the bond was likely issued...so it would be very hard to replace the full 6% interest rate returns when that semi-annual cash coupon came in. 

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