Question

How is yield to maturity related to the concept of rate of return? Please explain with an example in 4-5 sentences.

Answer 1

The yield to maturity represents the expectations of the investor’s as to the rate of return from certain securities. Investors will only invest in bonds which offer a coupon rate higher than the yield to maturity. For example , consider a bond with a coupon rate of 8%. Such a bond will sell at a premium if the YTM is lower than 8% because this bond is offering a return greater than the market expected return. Suppose the YTM increases beyond 8%, the bond will become less attractive and its price will decrease since its return will be lesser than the expected return.