How Do I Calculate Yield to Maturity on Bonds

[Page written by Andrew Marcus]
"Yield to maturity," a phrase that doesn't exactly roll off the tongue, refers to a calculation you'll want to make before buying or selling a bond.
The traditional method of making this calculation is remarkably confusing, particularly if you're averse to mathematics. Luckily, there are online tools at your disposal to make the calculation.
This page answers the question—as painlessly as possible—of how do I calculate yield to maturity on bonds.
Disclaimer

The content of this page is intended for general informational purposes only and is not a substitute for professional financial advice.

Introduction
- If you own bonds or plan to purchase them, yield to maturity is is an important figure to know. Unfortunately, it's also based on a horrifically hairy-looking calculation that's likely to give mathophobes flashbacks to high school. Luckily, we now have simple online applications to make this calculation for us. Still, you'll need to understand the basic idea, so here it goes.
What It Is
- Yield to maturity is essentially a way to measure the total amount of money you'll make on a bond, but instead of expressing that figure as a dollar amount, it's expressed as a percentage—an annual rate of return. For example, let's take an imaginary bond, say, for a company called Delicious Sandwich International:
Welcome back to math class. Have fun! (Creative Commons photo by Richard Riley)
- 1. You've just purchased it for $950.
  2. Like most bonds, its par value (the amount the issuer will refund you when the bond reaches maturity) is $1000.
    So at this point, you know you'll be making at least $50 ($1000 minus $950).
  3. The coupon rate of your Delicious Sandwich Intl. bond is 4%.
    The coupon rate is the annual interest rate you'll be paid in installments by the issuer.
    For the sake of calculating yield, the coupon rate is figured as compound interest, which assumes that you will reinvest the money you're paid in interest.
  4. The maturity date of your DSI bond is exactly three years from now.
    The maturity date is simply the date at which the issuer will pay you back.
- Taking all this information into account, the return on your investment in Delicious Sandwich Intl. (expressed as a dollar amount) will be $168.62. Here's where this total comes from:
  1. $50 (par value minus the purchase price)
  2. $118.62 (three years' worth of compound interest payments from the issuer at 4% of $950)
- Therefore, the yield to maturity for this bond is about 5.9%. Here's why:
  Your total return on your investment is $168.62.
  $168.62 is about 17.75% of $950.
  Divide that total rate of 17.75% by three (three years) and you get 5.9%.
- Now, brace yourself and have a look at the image at right, from Asset-Analysis.com. This is the mathematical formula you'd have to use in order to determine this figure.
Use the Calculator
- You're much better off using an online YTM calculator, like the one at MoneyChimp.
1. Go to Moneychimp's Bond Yield-to-Maturity page.
2. Scrawl down and click on popup calculator.
3. Enter the current price of the bond, the price for which it's listed on the bond market.
4. Enter the par value. This is the amount that the bond's issuer will owe the owner when the bond reaches maturity. It's almost always $1000.
5. Enter the coupon rate, i.e. the bond's stated interest rate.
6. Enter years to maturity the number of years before the bond reaches maturity.
  - Round up or down to the nearest year.
7. Press calculate.
8. Congratulate yourself: you're lucky enough to live in an era when the average person can calculate a bond's yield to maturity without jumping through burning hoops of mathematics.
Resources for How to Calculate Yield to Maturity on Bonds
- The Motley Fool: Bonds
- Fidelity.com: Prices, Rates, and Yields
- eHow.com: How to Calculate Bond Yields to Maturity
- MoneyChimp: Bond Yield-to-Maturity
- Yahoo! Finance: Bonds Glossary
- Sify Business: Yields of a bond demystified