Chapter 6 Readings_YTM vs Bond Coupon rates.docx - Bond...

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Bond ValuationSome important points to note:Yield to Maturity (YTM)is defined as the indicated (promised) compounded rate of returnan investor will receive from a bond purchased at current market price and held by theinvestor to maturity. It can also be defined as the interest rate expected at which theinvestment in bonds will achieve an NPV=0 (YTM is the IRR of the bond)The importance of YTM is for the bond valuation where it is used to calculate the indicative(assumed fair) market price for the bond based on current interest/coupon rate and held tomaturity.You should not confuse the coupon rate and the interest rate (YTM). The coupon rate isthe rate which is used to calculate the amount of interest paid per period. The YTM isthe interest rate that represents the investor expected rate of return on the bond.Therefore, if theYTM is greater than the coupon rate, the bond price is less than the facevalue. This type of bond is called adiscount bond.If the YTM isless than the coupon rate, the bond price is greater than the face value andthis type of bond is called apremium bond.What if the YTM isexactly the sameas the coupon rate? In this case, the bond price must beexactly same as the face value and the bond is called apar bond.

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