What YTM means

A bond pays a fixed coupon — say 7% of its ₹1,000 face value, every year — and returns the face value at maturity. But you rarely buy a bond at exactly ₹1,000. If you pay less, you earn the coupons and a gain on the way to ₹1,000; pay more and you earn the coupons minus a loss. Yield to maturity (YTM) is the one rate that accounts for both: the annual return you’d earn if you bought at today’s price, collected every coupon, and were repaid at maturity.

Technically, it’s the discount rate at which the present value of all the bond’s future cash flows equals its price. If that sentence sounds like the discounting post, it should — YTM is the same idea run backwards: instead of choosing a rate and computing a value, you know the value (the price) and solve for the rate.

The formula

                 C           C                 C + F
Price  =  ───────────  +  ─────────  + … +  ───────────
           (1 + y)¹       (1 + y)²           (1 + y)ⁿ

  C = annual coupon, F = face value, n = years to maturity
  y = YTM — solve for the y that makes the right side equal the price

There’s no closed-form solution; you iterate (a spreadsheet’s RATE or YIELD function does it). The intuition is what matters: price and yield move in opposite directions. Pay less, earn more.

Worked example: a ₹1,000 bond

Fictional bond, 7% annual coupon, 5 years to maturity, bought at ₹960. (Indian government bonds usually pay their coupon in two half-yearly instalments; one annual coupon keeps the arithmetic simple.)

First, the wrong-but-tempting number. Current yield is just coupon over price: ₹70 / ₹960 = 7.29%. It ignores that you’ll also be repaid ₹1,000 for a bond you paid ₹960 for.

Now solve for the rate that discounts every cash flow back to ₹960:

Year Cash flow Present value at 8.0%
1 ₹70 ₹64.81
2 ₹70 ₹60.01
3 ₹70 ₹55.57
4 ₹70 ₹51.45
5 ₹1,070 ₹728.22
Total   ₹960.07 ≈ ₹960

YTM = 8%. (Strictly, the rate that lands on ₹960 to the paisa is 8.002% — a hair above. Every figure here, and in the next post, uses the rounded 8%, which is why the total comes to ₹960.07.) The extra 0.71 points over the current yield is, roughly, the ₹40 gain to face value, spread over five years.

The same bond at different prices, or equivalently different market yields:

If the market yield is The bond trades at
5.0% ₹1,086.59
6.0% ₹1,042.12
7.0% ₹1,000
8.0% ₹960.07
9.0% ₹922.21

At a 7% yield the 7% bond is worth exactly par. Every point the market yield rises, the price falls — and by less each time (₹44, ₹42, ₹40, ₹38 here), which is a property called convexity you don’t need yet. The next post, on modified duration, puts a number on how much.

What YTM means on a debt fund factsheet

Every debt fund factsheet quotes a portfolio YTM — the weighted average YTM of the bonds it holds. Three reasons it isn’t the return you’ll get:

  1. It’s before expenses. Subtract the expense ratio. A portfolio YTM of 7.5% in a fund charging 0.8% is a 6.7% starting point.
  2. The fund doesn’t hold to maturity. Open-ended funds buy and sell constantly; as yields move, so do bond prices, and so does the NAV. Only a target-maturity fund, held to its end date, roughly locks in its YTM.
  3. Yields change. Coupons received get reinvested at whatever the market yield is then, not at today’s YTM.

So portfolio YTM is a good description of what the fund currently owns and a poor forecast of what you’ll earn. The debt funds post in the Tax series covered how the gains are taxed.

🧒 Explain it like I'm 10 (optional — skip if this is already clear)

Your uncle promises to give you ₹70 every birthday for five years, and ₹1,000 on the fifth one. A friend offers to sell you that promise for ₹960 today.

YTM asks: if I hand over ₹960 now and collect everything my uncle promised, what interest rate am I really earning? Because I paid less than ₹1,000 and get ₹1,000 back at the end, it’s a bit more than the ₹70-a-year suggests — about 8%, not 7%.

Common mistakes

  • Confusing coupon rate with yield. The coupon is fixed at issue. The yield depends on what you paid. A “7% bond” yields 7% only if bought at par.
  • Using current yield as the return. It skips the pull to par — 7.29% versus 8% here.
  • Treating a fund’s portfolio YTM as a promised return. It’s gross of expenses, assumes holding to maturity, and assumes yields don’t move. Three assumptions, all routinely false.
  • Forgetting the relationship runs both ways. If yields fall after you buy, your bond’s price rises — the mirror image of the risk.

Takeaway: YTM is the single rate that makes a bond’s future coupons and repayment worth exactly what you paid for it — 8% for a 7% bond bought at ₹960. Price and yield move in opposite directions, and a debt fund’s quoted YTM is a description of its holdings, not a forecast of your return.