Yield To Maturity

In today's society one way that people look to make money is through investing. New investors in the stock market should become familiar with the terminology used therefore; giving them an understanding of what is going on. Learning key words and phrases will make transactions easier to understand and help the investors to know where their money is going and why. There are key words and phrases that pertain to stocks and bonds separately. This paper will focus on the concept of yield to maturity. Yield to maturity (YTM) is the rate of return to the investor earned from payments of principal and interest, with interest compounded semi-annually at the stated yield, presuming that the security remains outstanding until the maturity date. YTM is considered a long-term bond yield expressed as an annual rate. The calculation of YTM takes into account the current market price, par value, coupon interest rate and time to maturity. (Investopedia, 2007)

The yield to maturity, or discount rate, is the rate of return required by the bondholders. The bondholder, or any investor, will allow three factors to influence his or her required rate of return. (Block, 2005)

1. Real rate of return - This is the rate of return the investor demands for giving up the current use of funds. It is the financial rent the investor charges for using his or her funds for any given period.

2. Inflation Premium - The investor requires a premium to compensate for the eroding effect of inflation on the value of a dollar. The inflation premium added to the real rate of return ensures that an investor receives their risk free rate of return.

3. Risk Premium - There are two types of risks: business risk and financial risk. (Block, 2005)

A bond is a certificate that serves as evidence of a debt and of the terms under which it is undertaken. (Allbusiness, 2007) It is greater than the current yield if the bond is selling at a discount and less than the current yield if the bond is selling at a premium. (Investor Words, 2007) The rate of return on a bond if it is held until the maturity. (fxwords, 2007)

Nearly all bonds are denominated in $1,000 face amounts and the investor pays a percentage of that face. If the investor buys a bond at 60 he or she will pay $600 for every $1,000 bond. Bonds pay interest in arrears; in other words, they pay interest only after it's earned. If our $1,000 bond pays interest in March and September, the March interest payment would compensate the investor for lending the issuer money from the previous September until March. The September interest payment compensates the investor for the loan of the money from the previous March until September. Even though bonds pay interest only in arrears, the investors who own bonds earn interest for each day the investor owns them. When bonds are traded, the seller of the bond is entitled to receive