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ABC of Fixed Income Investing - 4 Important Things That YTM Tells You
May 31, 2011

Series on basics of investing in fixed income funds-Part VI

Author : Niketa Agarwal

 ABC of Fixed Income Investing - 4 Important Things That YTM Tells You

Retail investors in India can be said to be reasonably well informed when it comes to investments in equities, real estate or even assets like gold or silver. The Fixed Income asset class, however, is not so well known. As a tool for diversification, and as a safe avenue for volatile times, understanding this class is important. Even experts agree that greater retail participation in the fixed income market in India will make it more robust. has always tried to draw notice to this asset class through various research and personal finance articles on the website. Taking this initiative further, we bring to you this series explaining basics of fixed income investments!


B. Understanding YIELD>>



E. Types of Risks>>

F. 4 Important Things That YTM Tells You

Yield-To-Maturity (YTM) is the measure of returns accrued by an investor when his investment is held till maturity. Therefore, YTM is an indicator of total returns that an investor would receive at the end of the maturity period.

I. YTM of an investment however undertakes certain assumptions which include:

  • The investment is held till maturity
  • The regular coupons before maturity are reinvested at the YTM rate as a lower rate would result in lower returns. In practice, if the reinvestment rate happens to be lower than the YTM rate, then the returns achieved are also lower.

II. Factors affecting YTM of a bond:

1. Coupon rate : Directly proportional to the yield. Higher coupon rate results in higher interest income provided to the investor and vice versa.

2. Years until maturity :  Directly proportional to yield. Greater the number of years to maturity, more coupon payments to the investor and vice versa.

3. Bond price : Indirectly proportional to yield. More return i.e., yield is accrued by an investor at a lower price and vice versa.

4. Difference between face value and price : On holding the bond till maturity, the investor receives amount equal to the face value of the bond. However, the difference between the face value and the price of the bond is paid by the investor. The discounted or premium on the price assumes importance in return calculation.

III. YTM and Debt Funds

1. YTM of a bond acts as its benchmark. The investor after looking at the benchmark can decide whether the bond accrues returns per his expectations because the YTM of a bond tells him the amount received by him at bond’s maturity.

2. Also, at the same time an investor can know if the bond being purchased by him is at a discount or premium.

3. YTM helps investors compare returns from other securities. By knowing the YTM of a bond, an investor gets an idea of the returns being accrued by him if he holds the particular bond till maturity. Therefore, he gets an opportunity to compare returns from different securities and then invest in the one matching his requirements.

4. YTM provides investors a chance to know their bond yields varying with current market prices. This is so, as the prices fall the yields rise and vice versa. Thus, an investor can evaluate and foresee his portfolio results.

IV. Points to note with YTM:

1. YTM and Bond Price : The bond’s price is dependent on purchasing the bond at discount, par or premium. The difference between the purchase price and the maturity price accounts for the returns achieved by an investor on his investment.

2. Comparing YTM : Suppose an investor has to purchase a bond with a maturity of 5 years. There are three bonds available in the market with 5 yrs maturity, carrying a 5% coupon rate on them at different purchase price on them. All of them have an annual payment.

Bond 1: INR 100(at par)                     

YTM: 5.0%

Bond 2:  INR 90(at discount)           

 YTM: 7.5%

Bond 3: INR 110(at premium)

YTM: 2.83%

 The 3 bonds carry different YTMs. Therefore, comparing the bond’s price with the YTM of the bond, the investor can know if he is getting the bond at a premium or discount. At the same time, he can anticipate his returns at maturity. Also, he can take his call and invest in a bond with a 5 year or a 10 year maturity issued to him at a premium or a discount.

3. YTM of premium and discounted bonds : In contrast to the general belief of investors, the discount bonds offer better returns than premium bonds. This is because the recovery in the discounted price is calculated as a part of return calculation. Premium bond owners, on the other hand, may have a higher coupon rate attached which can provide a greater yield.

For Example: If there are two bonds available with equal maturity of 10 years having a par value of INR 1000:

Bond 1: INR 900 (At discount)

Rate: 3%                        

YTM: 4.25%

Bond 2: INR 1200   (At premium)

Rate: 4%

  YTM: 5.36%

It can be seen that a premium bond with a higher coupon rate has a greater YTM than a discounted bond at lower coupon rate. Therefore, investors with similar maturity bonds should invest bonds having a higher YTM. Hence, rather than opting for discounted bonds that would give an investor a lower coupon rate till maturity, investors could look at premium bonds having a better YTM.

4. YTM of callable bonds : The callable bonds have a lower yield than its YTM. Even if the interest rates fall, it would not cause the bond price to rise higher than its call price (remains the same).

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We would continue with the series. Watch this space for more...


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