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Yield to Maturity vs. Holding Period Return

There are many yields associated with bonds. Some examples are yield to call, yield to worst, current yield, running yield, nominal yield (coupon rate), and yield to maturity (YTM). Most investors are concerned with the yield to maturity because if an investor purchases a bond and holds it until maturity, their return will equal the yield to maturity (YTM).

On the other hand, if the investor does not hold the bond until maturity (a common practice for long-term bonds), the total return will be equal to the yield over the length of holding or the holding period return (HPR). Due to uncertainty about interest rate fluctuations and holding period duration, the holding period return can be more difficult to calculate than YTM.

Key Takeaways

  • Yield to maturity is the payment a bondholder receives after holding a bond until it matures.
  • Holding period return is the total return a bondholder receives after holding a bond for a specific period.
  • Holding period return is a better measurement for bond investors who buy and sell bonds based on current bond prices.

Yield to Maturity

Yield to maturity (YTM), also known as book or redemption yield, reflects an investor’s yield for holding a bond until it matures. It does not account for taxes paid by the investor or incurred dealing costs. The YTM, often stated as an annual percentage rate (APR), assumes that all coupon and principal payments are made on time. Many computations also account for reinvested dividends, but this is not a required variable.

The YTM rate may differ from the coupon rate. The formula for calculating YTM, if done correctly, should account for the present value of the bond’s remaining coupon payments. The YTM formula can be seen as follows:

YTM = F V P V 1 where: F V = Face Value P V = Present Value begin{aligned} &text{YTM} = sqrt frac{ FV }{ PV } – 1 \ &textbf{where:} \ &FV = text{Face Value} \ &PV = text{Present Value} \ end{aligned}
YTM=PVFV1where:FV=Face ValuePV=Present Value

YTM is different from standard yield calculations because it adjusts for the time value of money. Since inverting the time value of money requires a lot of trial and error, YTM is best left for programs designed for that purpose.

Holding Period Return

Bond investors are not obligated to take an issuer’s bond and hold it until maturity. The return on a bond or asset over the period it was held is called the holding period return (HPR). There is an active secondary market for bonds. This means someone could buy a 30-year bond issued 12 years ago, hold it for five years, then sell it again. In such a circumstance, the bondholder doesn’t care what the yield of the 12-year-old bond will be until it matures 18 years later. If an investor holds the bond for five years, they only care about the yield they will earn between years 12 and 17.

The bondholder should attempt to calculate the bond’s five-year holding period return. This can be approximated by slightly modifying the YTM formula. The bondholder can substitute the sale price for the par value and change the term to equal the length of the holding period. The holding period return formula is as follows:

Holding Period Return = I + E P V I V I V where: I = Income E P V = End of Period Value I V = Initial Value begin{aligned} &text{Holding Period Return} = frac{ I + EPV – IV }{ IV } \ &textbf{where:} \ &I = text{Income} \ &EPV = text{End of Period Value} \ &IV = text{Initial Value} \ end{aligned}
Holding Period Return=IVI+EPVIVwhere:I=IncomeEPV=End of Period ValueIV=Initial Value

If the bond is still owned, use the current market price rather than the selling price to determine the present holding period return yield.

Sometimes, investors use the holding period return yield to assess the yields of different bonds. The results identify which bonds are more favorable investments.

What Does a YTM of 5% Mean?

A YTM of 5% means that a bond held until its date of maturity should give you an annual return of 5%.

IS YTM the Same as Interest Rate?

Yield to maturity is similar to interest rate because it is the annual interest earned on a bond. However, it uses the discounting method in which the present value is the sum of all future cash flows.

Is a Higher or Lower YTM Better?

Whether it is better depends on the conditions. A bond selling at a bargain might come with extra risks, so it helps to investigate the company issuing the bond before purchasing one with a higher YTM.

The Bottom Line

Yield to maturity is the annual yield given by a bond when it is held to maturity. Holding period return is the total yield an investor receives after holding a bond for a specific time. Each can be used to determine how long you can hold a bond if you’re deciding whether to hold a bond it until it matures, or only want to hold it for a short time.