A bond’s yield to maturity is the investor’s total annualized return for investing in the bond. A bond’s yield to maturity takes into consideration the annual income received by the investor along with any difference between the price the investor paid for the bond and the par value that will be received at maturity. It also assumes that the investor is reinvesting the semi-annual interest payments at the same rate. The yield to maturity is the most important yield for an investor who purchases the bond.
Yield to Maturity – Premium Bond
The Yield to maturity for a bond purchased at a premium will be the lowest of all the investor’s yields. While an investor may purchase a bond at a price that exceeds the par value of the bond, the issuer is only obligated to pay the bondholder the par value upon maturity. For example: An investor who purchases a bond at 110 or for $1,100 will receive only $1,000 at maturity and therefore will lose the difference of $100. This loss is what causes the yield to maturity to be the lowest of the three yields for an investor who purchases a bond at a premium.
Yield to Maturity – Discount Bond
The yield to maturity for a bond purchased at a discount will be the highest of all of the investor’s yields. In this case, the investor has purchased the bond at a price that is less than the par value of the bond. In this example, even though the investor paid less than the par value for the bond, the issuer is still obligated to pay them the full par value of the bond at maturity or the full $1,000. For example: An investor who purchases a bond at 90 or for $900 will still be entitled to receive the full par amount of $1,000 at maturity, therefore gaining $100. This gain is what causes the yield to maturity to be the highest of the three yields for an investor who purchases a bond at a discount.
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