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# Finance Formulas

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Yield to Maturity

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## The yield to maturity formula is used to calculate the

yield on a bond based on its current price on the
market. The yield to maturity formula looks at the
effective yield of a bond based on compounding as
opposed to the simple yield which is found using the
dividend yield formula.

## Notice that the formula shown is used to calculate

the approximate yield to maturity. To calculate the
actual yield to maturity requires trial and error by
putting rates into the present value of a bond
formula until P, or Price, matches the actual price of
the bond. Some financial calculators and computer
programs can be used to calculate the yield to
maturity.

Bond

a bond formula:

## For calculating yield to maturity, the price of the

bond, or present value of the bond, is already
known. Calculating YTM is working backwards from
the present value of a bond formula and trying to
determine what r is.

## The price of a bond is \$920 with a face value of

\$1000 which is the face value of many bonds.
Assume that the annual coupons are \$100, which is
a 10% coupon rate, and that there are 10 years
remaining until maturity. This example using the
approximate formula would be

## After solving this equation, the estimated yield to

maturity is 11.25%.

## Using the prior example, the estimated yield to

maturity is 11.25%. However, after using this rate as
r in the present value of a bond formula, the present
value would be \$927.15 which is fairly close to the
price, or present value, of \$920. Other examples
may have a larger difference.

## A higher yield to maturity will have a lower present

value or purchase price of a bond. In this example,
the estimated yield to maturity shows a present
value of \$927.15 which is higher than the actual
\$920 purchase price. Therefore, the yield to
maturity will be a little higher than 11.25%.

## Through trial and error, the yield to maturity would

be 11.38%, which is found by adjusting each
estimated rate until the present value equals the
price of the bond.

## Excel is helpful for the trial and error method by

setting the spreadsheet so that all that is required to
determine the present value is adjusting a fixed cell
that contains the rate.

Investment Return

A Financial

29 Card Game

Current Yield

Price 0.00

## Years to Maturity 0.000

= 0.000%

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