WFU Law School
Law & Valuation
4.2.3 Behavior of Bond Prices

4.2.4 Yield to Maturity

Bond investors commonly look at yield to maturity (YTM) -- the rate of return the bond offers at a specified price, if held to maturity. By computing bonds' YTM, it is possible to compare bonds with different coupon rates and prices.

A bond's YTM can be calculated by using the bond pricing formula and solving for the discount rate. If you know --

  • current price (B0)
  • annual interest (I)
  • par value (M)
  • years to maturity (n)

the yield can be found. Business calculators can make the calculation. Or you can use a process of trial and error with a spreadsheet.

Example 1

A 10.3% bond (par $1,000) sells for $1,090. That is, it trades at a premium. Assuming interest is paid semi-annually, and the bond has 7 years to maturity, what is the bond's current yield?

Answer. You can use a spreadsheet (computing yield either by trial and error until present value equals $1090, or using a "goal seek" function):

Trading at premium
Interest
10.3%
Years to maturity
7
Par (principal)
$1000.00
Present value
$1090.00
Remaining interest payments
$534.01
Principal payment
$555.99
Yield (discount rate)
8.56%


Example 2

Assume the same 10.3% bond (par $1,000) sells for $890. That is, it trades at a discount. Assuming interest is paid semi-annually, and the bond has 7 years to maturity, what is the bond's current yield?

Answer: You can use the same spreadsheet (computing yield either by trial and error until present value equals $890, or using a "goal seek" function):

Trading at discount
Interest
10.3%
Years to maturity
7
Par (principal)
$1000.00
Present value
$ 890.00
Remaining interest payments
$468.20
Principal payment
$421.80
Yield (discount rate)
12.72%
4.2.3 Behavior of Bond Prices

©2003 Professor Alan R. Palmiter

This page was last updated on: March 30, 2004