Yield to Maturity (YTM)

Key Components of YTM

1. Face Value (F): The amount that will be repaid to the bondholder at maturity. In India, this is typically ₹1,000.

2. Coupon Payment (C): The annual interest payment based on the bond’s coupon rate. For instance, if a bond has a 6% coupon rate and a ₹1,000 face value, the annual coupon payment is ₹60.

3. Current Market Price (P): The price at which the bond is purchased in the market. This can be higher or lower than the face value.

4. Time to Maturity (n): The number of years left until the bond matures and the principal is repaid.

YTM Formula

A simple formula to approximate YTM is as follows:

YTM = [C + (F – P) ÷ N] ÷ [(F + P) ÷ 2]

Where:

• C = Annual coupon payment (in INR)

• F = Face value of the bond (in INR)

• P = Purchase price of the bond (in INR)

• n = Years to maturity

Benefits of YTM

1. Comprehensive Return Estimate: YTM includes both the interest income (coupon payments) and any capital gain or loss (from purchasing the bond below or above its face value), giving a complete picture of potential returns.

2. Standardised Comparison: It allows investors to compare bonds with different prices, coupon rates, and maturities on an equal footing.

3. Portfolio Planning: YTM helps align bond investments with your time horizon and risk appetite, ensuring that they fit your long-term financial goals.

Challenges of YTM

1. Assumptions May Not Hold: The calculation assumes that coupons will be reinvested at the same rate as the YTM and that the bond will be held to maturity. This may not always happen in real life.

2. Interest Rate Risk: YTM is sensitive to market interest rates. If interest rates rise, bond prices generally fall, and vice versa, which can affect the expected return.

3. Credit Risk: A higher YTM often reflects higher credit risk, meaning the bond may be more likely to default. This is especially true for lower-rated bonds.

4. Tax Not Included: YTM does not account for taxes on the coupon income or capital gains, so the actual return could be lower after taxes are factored in.

5. Approximation: The YTM formula provides an estimate of potential return. In practice, actual returns may differ due to changes in market conditions, issuer-specific events, or other factors.

Conclusion

YTM is an important tool for bond investors in India, especially in 2025, as it allows for a standardised measure of expected returns, making it easier to compare different bonds and debt funds. However, investors should be mindful that YTM is based on certain assumptions and does not capture all the real-world risks, including market fluctuations and taxes. Therefore, it is essential to use YTM alongside other metrics and consider all risks and tax implications when planning investments.