The yield to maturity (YTM) measures the interest rate, as implied by the bond, which takes into account the present value of all the future coupon payments and the principal. It is assumed that bond holders can invest received coupons at the YTM rate until the maturity of the bond; according to risk-neutral expectations, the payments received should be the same as the price paid for the bond.
Let's take a look at an example of a 5.75% bond that will mature in 1.5 years with a par value of 100. The price of the bond is $95.0428 and coupons are paid semi-annually. The pricing equation can be stated as follows:
Here:
- c is the coupon dollar amount paid at each time period
- T is the time period of payment in years
- n is the coupon payment frequency
- y is the YTM that we are interested in solving
To solve the YTM is typically a complex process...
