The key difference between Bond Yield and Yield to Maturity (YTM) lies in what each metric represents and how they are calculated.
Bond Yield:
1. Bond yield refers to the income generated by a bond as a percentage of its current market price. It reflects the return an investor earns on a bond based on its current price, without considering the bond's maturity date.
2. Types:
Coupon Yield (Nominal Yield): Represents the annual interest payments (coupons) relative to the bond's face value (par value).
Current Yield: Represents the annual interest payments relative to the bond's current market price.
3. Calculation Examples:
Coupon Yield: If a bond pays ₹10 annually and its face value is ₹1,000, the coupon yield is 10÷1,000* 100 = 1%
Current Yield: If the same bond is trading at ₹950, the current yield is
10÷950 *100= 1.05%
4. Purpose: Bond yield helps investors assess the immediate income return from holding a bond based on its current price.
Yield to Maturity (YTM):
1. YTM represents the total return an investor can expect to earn if the bond is held until maturity. It considers not only the bond's coupon payments but also any capital gain or loss if held until maturity.
2. Calculation: YTM is calculated by solving the present value of all future cash flows (coupons and principal repayment) discounted at the bond's yield, considering the purchase price.
3. Example: If a bond is purchased at ₹950, pays ₹10 annually with a face value of ₹1,000, and matures in 5 years, YTM is calculated iteratively to find the discount rate that equates the present value of future cash flows to ₹950.
4. Purpose: YTM helps investors assess the total return potential of a bond, considering both income from coupons and capital gains or losses if held until maturity.
Key Differences:
Focus: Bond yield focuses on the income return relative to the bond's current market price at any given time.
Time Frame: YTM considers the entire holding period until maturity, incorporating reinvestment of coupons at prevailing market rates and the bond's price appreciation or depreciation over time.
Calculation Method: Bond yield is straightforward and can be calculated using coupon payments relative to current price. YTM requires iterative calculation to account for the time value of money and reinvestment assumptions.
Use Case: Bond yield is useful for assessing current income potential, while YTM is used for evaluating the total expected return over the bond's entire life.
In summary, bond yield provides a snapshot of current income relative to price, whereas YTM offers a comprehensive view of total return over the bond's life, considering both income and capital gains/losses. Both metrics serve different purposes in bond analysis and are essential for investors in making informed investment decisions based on their objectives and risk tolerance.