What Is Yield to Maturity?
Yield to maturity is the annual return you would earn on a bond if you held it until it matured and reinvested every coupon at that same rate. It is a single number summarising a whole payment schedule, and its reinvestment assumption is the part that rarely holds.
Every bond is a schedule: some coupons, then the principal back. Yield to maturity compresses that whole schedule into one annual percentage — which is useful, and which requires two assumptions that are rarely stated out loud.
How it works
It is the discount rate that makes the bond’s future payments equal its current price. Every coupon, plus the principal at the end, discounted back — and the rate that makes that sum match what you paid is the yield to maturity.
Assumption one: you reinvest every coupon at that same rate. If the yield is 5%, the figure only holds if each payment goes back to work at 5%. Rates move, so this is a projection rather than a measurement.
Assumption two: you hold to maturity. Sell in year three of a ten-year bond and the number you were quoted described a path you did not take.
Price and yield move opposite ways
Buy below face value and the yield exceeds the coupon, because you collect the coupons and a capital gain at redemption.
Buy above face value and the yield falls short of the coupon, because the capital loss at redemption comes off the total.
This is the source of the rule that bond prices fall when rates rise. New bonds are issued at the new higher rate, so an old one paying less must get cheaper until its yield matches.
A worked example
A bond with a 4% coupon, ten years left, bought at face value of 100. Yield to maturity is 4%, because you paid par — coupon and yield coincide only here.
Now rates rise and the same bond trades at 85. The coupon is still 4 in cash. The current yield is 4/85 ≈ 4.7%. The yield to maturity is higher still, because you also collect 15 of capital gain when it redeems at 100.
Three different yields, one bond, same day. The coupon rate, the current yield, and the yield to maturity are all correct and all describe different things — which is why “the yield” is an incomplete sentence.
What the number leaves out
Tax. Coupons are usually taxed as income, and the rate depends on the account and the jurisdiction. The quoted yield is gross, and the net figure is the one you spend.
Costs. The spread paid buying the bond comes out of the realised return, and in bonds the spread is wide relative to shares because most of the market trades between dealers rather than on an exchange.
Credit. The whole calculation assumes every payment arrives. A yield of 7% on a corporate bond is not three points better than a 4% government one — it is compensation for the possibility that the schedule stops, and the yield figure has no way of expressing how large that possibility is.
And the path. Yield to maturity describes an outcome at one date and says nothing about what the holding is worth in between. A bond that will redeem at par can still be down twenty percent in year three, which matters enormously to anybody who might need to sell.
The original data
Use this site’s thirty-year fee measurement as the scale: an annual drag of 5 basis points costs 1.5% of the final balance, 20 costs 5.8%, 75 costs 20.2%, and 150 costs 36.5%.
That is the same compounding arithmetic yield to maturity runs. A difference of 20 basis points in yield — 4.00% against 4.20% — is worth 5.8% of the final amount over thirty years. It is why bond investors argue over hundredths of a percent, and why the reinvestment assumption matters: if coupons come back at 2% instead of 4%, the realised return is not the number on the screen.
And costs come out first. A round trip on this site’s shared series costs 0.0098, about 2% of the median bar range of 0.493 — charged whether or not the projection holds.
And one variant worth knowing: yield to worst. Where a bond has features that can end it early — a call, a put, a sinking fund — yield to worst reports the lowest yield across every possible outcome. It is the conservative figure and the one a careful buyer checks, because the issuer will exercise whichever right suits them rather than whichever suits you.
When it fails
The characteristic failure is comparing two bonds on yield to maturity alone. The higher number looks better, and the comparison silently assumes both will be held to the end, both will reinvest at their quoted rates, and neither will default. A corporate bond yielding 7% against a government one yielding 4% is not offering three points of free return — it is offering compensation for a risk the yield figure has no way of expressing.
A second failure is treating it as a promised return. It is a projection with two conditions attached and neither is certain.
A third is ignoring reinvestment in a falling-rate world, where coupons come back at progressively worse rates and the realised return drifts below the quoted one.
A fourth is comparing yields across tax treatments, where the gross figures are equal and the net ones are not.
And a fifth is applying it to a callable bond, where yield to call is the number that matters because the issuer decides when the schedule ends.
A last practical note. Platforms differ on whether they quote yield to maturity, yield to worst or current yield as “the yield,” and they rarely say which. Checking that label before comparing two bonds is the difference between a real comparison and an accidental one.
Related
Current yield covers the simpler measure that ignores maturity. Coupon yield covers the fixed cash payment underneath both. And bond duration covers how far the price moves when yields change.
Yield to maturity is quoted like a fact and it is a projection with two conditions attached, both of which are usually wrong. You have to hold the thing for its whole life, and you have to reinvest every payment at exactly the rate you started with. Almost nobody does either.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.