'Yield to Maturity (YTM)' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Yield to Maturity is also widely known in investment and analyst circles by its acronym YTM, as well as by the phrases book yield and redemption yield. This represents the aggregate return which investors can expect to receive for a bond if they keep the security until the end of its actual life. This is why YTM is generally called a longer term bond yield even though it is still expressed as a rate per year. Another way of saying this is that this proves to be the investment’s internal rate of return for the bond if the owner keeps it all the way through maturity. This assumes of course that the bond issuer makes all of its payments both on time and in the full amounts contracted.
In order to understand the Yield to Maturity calculations, it is critical to realize that the formula assumes all coupon payments the issuer makes will be exactly reinvested for the rate of the current yield of the bond. The formula similarly considers the bond’s par value, current price on the market, term to maturity, and coupon interest rate. All of this makes the YTM a complicated yet good formula for determining the return of a bond. It allows investors to effectively compare and contrast those bonds which possess varying coupon rates and maturity dates.
There are several different ways to figure out the Yield to Maturity. It is a complicated formula so many investors simply fall back on pre-printed and -figured bond yield tables. Determining the exact YTM requires either a software program or the use of a financial or business calculator. This is because the value for a basis point drops as the price for a bond increases in an inverse manner. Many firms actually calculate YTM for six month time frames as well as on an annual basis. They do this because most coupon payments take place twice per year.
A significant difference between Yield to Maturity and the current yield lies in the fact that the YTM takes into account money’s time value, while the simplified current yield computations will not. This is why investors often prefer to utilize the YTM instead of the current yield when they are crunching number on bond returns to compare and contrast with other bond issues and different types of investments.
There are a number of similar yet still variations on the classical Yield to Maturity figure. These should never be confused with the true YTM. Among these are the Yield to call (YTC), Yield to put (YTP), and the Yield to worst (YTW). Yields to call go with the assumption that the bond issuer will recall the bond by repurchasing it in advance of it reaching maturity. This assumes that the resulting cash flow period will be shortened. Yield to put is much like the YTC, only the seller is allowed to and may sell the bond back to its issuer on a specific date for a pre-determined price. Finally, Yield to worst means that the bonds in question can be put, called, or even exchanged. This is why YTW bonds usually have the smallest yields from the three variations on YTM and the YTM rate itself.
There are some important limitations to the utility of Yield to Maturity as a measurement for comparing and contrasting various bonds against other bonds and other forms of investment classes as well. With YTM, these calculations never take into account the actual taxes which investors will have to pay on the bonds. This is why YTM is sometimes called the gross redemption yield. These calculations for yield also do not factor in either selling or buying costs for the bonds themselves.
It is also important to keep in mind that YTM is limited by the fact that both it and current yields are estimate calculations. They can not ever be 100 percent accurate or reliable. The true returns will vary with the realized price of a bond when a holder sells it. The prices of such bonds can vary significantly as the market actually determines them (and not the issuer). Such variations in the value of a bond and the price for which it is sold may impact the YTM substantially. They more drastically impact the current yield calculations and measurement in the end.