The YTM is the most important yield indicator for a bond investment. It factors in the nominal yield, bond price and length of maturity held.

When investors buy bonds, the coupon rate is important, but if the bond price is higher than par - the yield to maturity will be lower. If the bond is bought at a discount, the yield to maturity will be higher.

The nominal yield (coupon) is a fixed rate that is only paid to par value. All bonds redeem at par as well. So, if the investment is purchased below or above par, the yield will be different.

Premium and Discount Bond Yield

The YTM is actually the current interest rate on a particular bond or similar bonds. If a 7% bond is availale, but interest rates are actually only 5%, the broker or the market will price that bond higher (premium) - to reflect the current interest rate environment. The broker is not going to sell a 7% bond at par when interest rates are 200 basis points lower. A premium will be the market.

If the interest rate climate on these bonds is 5%, the security will be priced for a yield to maturity of around 5%. So, the investor is really getting a 5% overall rate of return on this bond, if held to maturity - even though the nominal yield is 7%. Interest is never paid to a premium or discount. It is only paid to par.

If an investor is seeking higher current income, having a higher coupon rate is important. The yield to maturity is not a paying yield, it is an overall rate of return of the investment.

If a person is not seeking current income, they can choose a below market coupon bond and buy it a discount. Doing this will allow the investor to pay less and earn less interest, but the overall yield to redemption or maturity will be higher.

YTM uses all the components of a bond investment to come up with a true overall yield on the security.

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Copyright 2006 American Investment Training, Inc.