Chapter 3

Measuring yield

Current Yield
Current yield relates the annual coupon
interest to the current market price of the
bond
Considers only coupon interest income
Does not consider capital gain or loss
Does not consider reinvestment income

Yield to Maturity
Also called the internal rate of return of a
bond
The interest rate that will make the present
value of the cash flows equal to the price (or
initial investment)
Rate of return promised to an investor if you
purchased the bond at the current market
price given coupon and maturity of the bond

Yield to Maturity
Yield to maturity will equal the actual rate of
return to a bond investor if and only if
The investor holds the bond to its maturity and
All interim cash flows in the form of coupon
payments are reinvested at the computed yield to
maturity

 The YTM takes into account

Coupon interest income
Capital gain or capital loss
Interest on interest income

How much YTM tells us about a bonds actual

return?
Depends on reinvestment risk and
Interest rate risk

Yield to Call
Usually, bond market participants compute
both the yield to maturity and the yield to call
for a callable bond and use the lower of the
two to price bonds
When bonds are trading at or above a
specified crossover point, which is
approximates the bonds par value plus one
years interest, the YTC will normally provide
the lowest yield measure

 When is the bond issuer most likely to call

back callable bonds?
When the bond price rises to the price above par
and the computed YTM becomes low enough that
it would be profitable for the issuer to call the
bond and finance the call by selling new bonds in
the market.