When it comes to bonds, there are a few key terms that you need to know in order to make informed decisions. Two of the most important terms are yield to maturity (YTM) and current yield (CY). While both YTM and CY measure bond yields, they use different calculations and can provide investors with different information. In this blog post, we’ll break down the differences between YTM and CY so you can understand which one is right for you.
What is YTM?
YTM, or yield to maturity, is the percentage rate of return that an investor will earn on a bond if it is held until the maturity date. YTM takes into account both the coupon payments and the capital gains that will be earned from the bond’s price appreciation. YTM is typically higher than the current yield, which only accounts for the coupon payments. YTM is a useful measure for comparing different bonds, as it provides a more accurate picture of the bond’s total return. However, YTM can be difficult to calculate, and it may not be representative of the actual return that an investor will earn if they sell the bond before maturity.
What is the Current Yield?
The Current Yield is a measure of the yield of a bond or other fixed-income security and is typically expressed as a percentage. The Current Yield is calculated by dividing the interest payments by the Current Price. For example, if a bond has a coupon rate of 5% and a Current Price of $100, the Current Yield would be 5%.
The Current Yield can be useful in comparing different bonds, as it provides a clear indication of the return that an investor can expect to receive. However, it is important to remember that the Current Yield does not take into account the capital gains or losses that may occur over the life of the bond. As such, it should only be used as one element in making investment decisions.
Difference between YTM and Current Yield
- Yield to maturity (YTM) is the rate of return an investor will realize on a bond if the bond is held until it matures and all coupon and principal payments are made on time. YTM assumes that all coupon payments are reinvested at the YTM rate. YTM is also known as “book yield” or “redemption yield.”
- The current yield is simply the annual interest payment divided by the market price of the bond. For example, if a bond has a YTM of 6% and pays $60 in interest annually, its current yield would be 10% (($60/$600)*100). The current yield will fluctuate over time as the bond’s price changes.
- While YTM takes into account the time value of money and reinvestment of coupons, current yield does not. As a result, YTM is generally seen as a more accurate measure of return. However, both YTM and current yield are useful in different situations. For example, current yield can be used to compare different bonds with different durations or different coupon payments. Yield to maturity may be more important to investors who plan to hold a bond until it matures.
In short, the current yield is more relevant to individual investors because it reflects what they will earn on their investment in the present. The YTM calculation takes into account the timing of all cash flows, which may be irrelevant or difficult for individuals to consider. However, for those interested in learning about and calculating YTM, there are plenty of resources available online.