How is the Yield to Maturity computed?
The calculation for YTM is based on the coupon rate, length of time to maturity and market price. It is the Internal Rate of Return on the bond and can be determined by equating the sum of the cash-flows throughout the life of the bond to zero. A critical assumption underlying the YTM is that the coupon interest paid over the life of the bond is assumed to be reinvested at the same rate. The YTM is basically obtained through a trial and error method by determining the value of the entire range of cash-flows for the possible range of YTMs so as to find the one rate at which the cash-flows sum up to zero. So, say, a G-Sec – 8.00% GOI Loan 2004 with only 2 cash flows remaining to maturity as under: Maturity Date: 30th January 2004 Interest Payment Dates: 30th January, 30th July and trading currently at Rs. 115 for 1 Unit, will have a YTM as follows: Settlement Date: 17th March 2003 (Date at which ownership is transferred to the Buyer) Frequency of Interest Payments: 2 Day Count Convention
