A bond’s rate of maturity refers to the actual amount of interest income that is earned on the bond each year and is pegged on its face value. On the other hand, a bond’s yield to maturity refers to the estimated rate of return of a bond. The assumption held in the yield to maturity is that the bond is maintained to its maturity and not called. The rate of maturity of a bond represents its coupon rate that tends to be fixed throughout the period. The rate of maturity of a bond represents the interest rate that is set when the bond is issue (Forbes, Hatem, & Paul, 2008). This represents the amount of income earned on a bind expressed as a percentage of the original investment. One key feature of the rate of maturity of a bond is that it is expressed as a percentage of the par value of the bond and remains constant throughout the lifespan of the bond.
On the other hand, the yield to maturity represents the overall interest earned on a bond that is held until its maturity. This represents the discounted rate at which the sum of all the future cash flows equals the price of the bond. The future cashflows are inclusive of coupons and principal repayment. The yield to maturity is expressed as an annual rate and may different from the coupon rate of the bond. The yield to maturity holds the assumption that the coupon and principal payments are timely made. The yield to maturity does not mandate that dividends be reinvested but its computation is based on this notion. It does not consider the taxes paid by the investors or the costs involved in the purchase (Forbes, Hatem, & Paul, 2008).
In most cases, investors make investing decisions and strategies based on the yield to maturity as compared to the bond’s rate of maturity. One of the reasons that makes the bond’s rate of maturity different from the yield to maturity is on the fact that the rate of maturity tends to fixed throughout the period because it is based on the face value of the bond that remains unchanged throughout the period. On the other hand, the yield to maturity approximates the average return for the bond over its lifespan up to the time it matures. The calculation of the yield to maturity is based on the coupon rate, the price of the bond, variance between the price and face value, and it’s time to maturity (Forbes, Hatem, & Paul, 2008). This makes the yield to maturity a more accurate method of determining the effective rate of return since it considers the actual market value of the bond.
In an example of a bond with a face value of $1000 and makes semi-annual payments of $20, it annual rate to maturity will be equivalent to 4% ($20+$20/1000 X 100). This rate will remain fixed throughout the maturity period of the bond irrespective of the market value that the bond trades in. The yield to maturity on the other hand, is affected by the market price of the bind. The yield to maturity of a bond is inversely related to its price. This implies that when the price of the bond increases, its yield to maturity reduces and vice versa. If the bond indicated above sells at a price of $1100, the yield to maturity then is 3.63% ($40/$1100 X 100). If the bond’s price reduced to $800, then yield to maturity would be 5% ($40/$800 X 100.
Forbes, S. M., Hatem, J. J., & Paul, C. (2008). Yield-to-Maturity and the Reinvestment of Coupon Payments. Journal of Economics and Finance Education, 7(1), 48-51.
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