Also known as the yield to maturity formula, the yield to maturity equation is a mathematical formula that is used to determine the total annual return that an investor will receive if an asset such as a bond is held until maturity. The idea behind this type of equation is to aid investors in determining if continuing to hold the asset is worth the time and effort, or if the asset should be sold and the proceeds used to secure a different asset. While somewhat complicated, the yield to maturity equation does make it easier to ensure the level of return is in line with the investor’s goals.
The basics of the yield to maturity equation requires identifying the original purchase price of the asset, the rate of interest that applies, and the number of years that remain until the asset reaches full maturity. Identifying the actual dollar figure of the annual coupon payment associated with the bond issue is also crucial to making use of the equation. Identifying the par value that the asset could be sold at currently will also aid in determining the current yield to maturity (YTM).
While the structure of a yield to maturity equation can be somewhat daunting, financial advisors can often help investors determine how to arrange the required data so that the formula is less daunting. Since the process calls for relating certain data with other factors, the equation can be calculated in segments or increments. As each segment is resolved, the investor moves closer to identifying the yield to maturity in the form of a percentage that can easily be converted into an actual amount. From there, it is a simple task to determine if the current yield has slipped somewhat, owing to a shift in interest rates that apply to bond carrying a variable rate of interest, or if the yield is still within a range that is in line with the anticipated yield projected by the investor.
Taking the time to make use of the yield to maturity equation is helpful for investors in a couple of difference scenarios. Investors who already hold the asset can make sure the return is tracking at a level that is considered acceptable, which in turn indicates the asset should be held. Investors who have the opportunity to purchase bond issues at a discount can also use this formula to determine if the yield to maturity is sufficient to justify the purchase of the bond, given the rate of interest and the amount of time left before the bond fully matures.