Financial Markets and Institutions Exam 1 Practice

Yield to maturity is the rate that makes the present value of all future bond cash flows (the periodic coupons and the redemption at maturity) equal to the bond’s current price. In other words, it’s the internal rate of return you would earn if you hold the bond to maturity and reinvest the coupons at that same rate.

This pricing relationship means the bond’s price today is the sum of each future cash flow discounted at the YTM. Because discounting with a higher rate lowers present value, prices fall as YTM rises, and prices rise as YTM falls—the two move inversely.

YTM isn’t the coupon rate, which is just the fixed annual coupon divided by par. It also isn’t the current yield, which is the annual coupon divided by price. And it isn’t the required return on equity investments. The described description captures how YTM ties to bond pricing and why they move together inversely.