What is Yield to Maturity & Why it Matters?

In summary

A loan against bonds lets you borrow against eligible bond holdings without selling them. Your bonds remain pledged as collateral while you use the sanctioned funds.

• LTV ratio: For a loan against bonds in India, lenders may provide 60%–80% of the bond value, depending on the security.
• Eligible bonds: Government bonds, corporate bonds, tax-free bonds, and other approved listed bonds may be accepted.
• Interest rate: A loan against debt securities may carry an interest rate of 8%–14% p.a., based on the lender and pledged bonds.
• Basic eligibility: Applicants must meet the lender’s age, income, residency, credit, and security-ownership requirements.
• Required documents: Common documents include PAN, address proof, income details, bank statements, and proof of bond ownership.

Check your eligibility for a loan against bonds online with Bajaj Finance and review the applicable terms before applying.

What is yield-to-maturity

Yield to maturity is the discount rate that equates a bond’s market price with its future cash flows. These cash flows include every remaining coupon payment and the face value repaid at maturity. YTM is expressed as an annualised percentage. It represents the return expected when the investor holds the bond until maturity. The calculation assumes the issuer makes every scheduled interest and principal payment. It also assumes the investor reinvests each coupon payment at the same YTM.

For example, a bond may have a 7% coupon rate but trade below its face value. Its YTM may exceed 7% because the investor also receives a capital gain at maturity. A bond trading above face value may have a YTM below its coupon rate. The investor receives the face value at maturity, which is lower than the purchase price. YTM is sometimes called redemption yield or book yield. However, it should not be confused with current yield or the coupon rate.

If you are looking for a safe investment option, you can consider fixed deposit. They offer guaranteed returns and a fixed interest rate throughout your investment tenure.

YTM helps investors compare bonds using one annualised measure. This is useful because two bonds may have different coupons, prices, and maturity dates. The coupon rate only measures annual interest against the bond’s face value. It does not consider the current market price or the gain or loss at maturity. Current yield considers the market price but ignores the maturity gain or loss.

YTM includes the market price, coupons, face value, and remaining tenure.

YTM therefore provides a broader comparison than either the coupon rate or current yield. However, investors should compare bonds with similar credit quality, structure, and maturity. A higher YTM does not automatically make one bond more suitable than another.

YTM works by discounting every future bond payment to its present value. The calculated present value must equal the bond’s current market price.

The exact relationship is:

Bond price = Present value of all coupon payments + Present value of the face value

For an annual coupon bond, the formula is:

P = C ÷ (1 + YTM)¹ + C ÷ (1 + YTM)² + … + (C + F) ÷ (1 + YTM)ⁿ

Where:

• P: Current market price
• C: Annual coupon payment
• F: Face value
• n: Remaining years until maturity
• YTM: Yield to maturity

The exact YTM cannot usually be isolated through simple rearrangement.

Financial calculators, spreadsheets, and bond platforms solve it through iteration.

A commonly used approximation is:

Approximate YTM = [C + (F − P) ÷ n] ÷ [(F + P) ÷ 2] × 100

This formula provides an estimate rather than the exact internal rate of return.

Why is yield-to-maturity useful

YTM helps investors evaluate bond returns beyond the stated coupon rate.

Its main uses include:

• Bond comparison: YTM helps compare bonds with different coupons, prices, and maturity dates.
• Discount evaluation: It shows how a discounted purchase price affects the expected annualised return.
• Premium evaluation: It reflects the maturity loss when a bond is purchased above face value.
• Portfolio planning: Investors can compare the estimated return with their investment period and income requirements.
• Market assessment: YTM reflects how market rates and bond prices affect expected returns.
• Issuer pricing: Issuers can review yields on comparable bonds when pricing a new issue.
• Credit assessment: A high YTM may signal greater perceived credit risk when comparable bonds have lower yields.

YTM works best when used with credit ratings, duration, liquidity, and bond terms.

Also Read: Difference Between Yield and Interest Rate

Yield to Maturity in the investment landscape

YTM provides a common measure across many fixed-income securities. However, it should form only one part of the evaluation.

Fixed-income investments

Investors can use YTM to compare government securities and corporate bonds with similar characteristics. The comparison should consider credit quality, maturity, coupon structure, liquidity, and embedded options. A corporate bond may offer a higher YTM than a government security. The difference may compensate for greater credit risk, lower liquidity, or both. A higher number alone does not establish that the bond offers better value.

Long-term planning

YTM can help investors estimate the annualised return from holding a bond until maturity. Investors can compare this estimate with the timing of future financial goals. However, reinvestment rates may change during the holding period. The issuer may also call the bond early when the bond terms allow it. Investors should therefore match maturity, cash flows, and risk with their planned requirements.

Yield to maturity example

Suppose an investor buys a bond for Rs. 900. The bond has a face value of Rs. 1,000 and matures after five years. It pays an annual coupon of Rs. 80. The investor receives Rs. 80 each year and Rs. 1,000 at maturity. As the bond was purchased below face value, the investor also receives a Rs. 100 maturity gain.

The approximate YTM is:

Approximate YTM = [80 + (1,000 − 900) ÷ 5] ÷ [(1,000 + 900) ÷ 2] × 100

Approximate YTM = [80 + 20] ÷ 950 × 100

Approximate YTM = 10.53%

The exact YTM is approximately 10.68% when calculated by discounting every cash flow. This difference shows why the simplified formula should be treated as an approximation.

Conclusion

Yield to maturity estimates a bond’s annualised return when it is held until maturity. It considers the market price, coupons, face value, and remaining tenure. However, the estimate assumes timely payments and reinvestment at the same yield. Actual returns may differ because of default, early sale, call provisions, costs, taxes, or changing reinvestment rates.Use YTM with credit quality, duration, liquidity, and bond terms before comparing investments.

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