11th letter to friends of Brunei (Bond's valuation [Part 3])

The most commonly used statistics for bond's valuation is "Yield To Maturity" (YTM). When newspaper talks about bond's yield, they are referring to YTM.

YTM will give you an estimate of the total return of the bond, assuming the bond is held to maturity and all coupons are reinvested at a rate equal to YTM.

Bond price = Coupon/(1+YTM) + coupon/(1+YTM)2 + ......coupon /(1+YTM)n+ Par value/(1+YTM)n

I myself find above formula difficult to remember, so i also rely on financial calculator to calculate YTM. The key strokes are as follows:

FV = par value of bond

PV = current bond price

PMT = annual coupon value

n = number of years to maturity (if coupon is received 2 times a year, then use n x 2)

i % = YTM

Example 1: The YTM for a zero coupon bond selling at $235 with 10 years to maturity, if it is compounded annually, is

a. 14.25%

b. 16.05%

c. 17.15%

d. 15.58%

Example 2: An 8% coupon bond has a market price of $900 and 20 years to maturity. What is its YTM?

a. 8%

b. 8.50%

c. 9.10%

d. 10%

Some interesting fact about YTM (i.e. bond's yield)

1. As bond price is fluctuating, the YTM is also a fluctuating figure.

2. When bond price is down, YTM is expected to rise.

3. When the bond price is up, the YTM will go down.

4. YTM is not an immediate return data, it simply refers to if one invest in a bond with YTM of 8%, he needs to hold the bond to maturity & reinvest the coupon at YTM in order to realise the yield.

* Example 1: Using my faithful FC-100 (Casio financial calculator). PV= -235, FV=1000, n=10, comp i%(YTM) = 15.58%. Hence, the answer is d.

** Example 2: PV = -900, FV = 1000, PMT = 80, n = 20, comp i%(YTM) = 9.10%. Hence, the answer is c.