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Frederick University
2014
Yield to Maturity
The yield to maturity is the
interest rate that makes the
discounted value of the future
payments from a debt instrument
equal to its current value (market
price) today.
It is the yield bondholders receive if
they hold a bond to its maturity.
Bonds: 4 types
Discount bonds - zero coupon bonds
(government bonds)
fixed payment loans
coupon bonds
(government bonds, corporate bonds)
consols
example
90 day bond,
P = 9850, F = 10,000
YTM solves
9850
10,000
(1 i )
90
365
9850
1 i
10,000
(1 i )
90
365
90
365
10000
9850
10000
1 i
9850
10000
i
9850
365
365
90
90
F-P
idb =
F
360
d
example
90 day bond,
P = 9850, F = 10,000
discount yield =
150 360
X
6%
10,000 90
why?
F in denominator
360 day year
i is annual rate
but payments are monthly, &
compound monthly
i = i/12
300
300
300
5000
...
2
60
1 i / 12 1 i / 12
1 i / 12
Coupon bond
a 2-year coupon bond
a face value F = 10,000,
a coupon rate i = 6%,
a price P =9750.
bond price = PV(future bond
payments)
The coupon payments are
[face value x coupon rate]/2 =
or:
i = 7.37%
3 important points
Consols (or
perpetuities)
Consols (or perpetuities) promise
interest payments forever, but never
repay principal.
Bond Yields
P = PV of cash flows
Current yield
ic =
example
600
ic =
9750
= 6.15%
holding period
interest payments
resale price
example
300 at 6 mos.
300 at 1 yr.
9900 at 1 yr.
2
i
i
1
1
2
2
i/2 = 3.83%
i = 7.66%
why i/2?
interest compounds annually not
semiannually