There is some fundamental difference between Stocks and Bonds. These differences define the way both the asset classwork and how the return is yielded. Yield to Maturity and Current yields are the two different forms of getting returns from bonds. Depending on the type of bond purchased, the returns vary.
YTM vs Current Yield
The main difference between YTM and Current Yield is that YTM is the result that is yielded after the bond has matured. It is the rate of return that a person will receive after the maturation period of the bond. The current yield on the other hand is the rate of return that is yielded at the current moment.
Yield to Maturity or YTM is the rate of return that a person will receive after the maturation period of a bond. Every bond is bought under a maturation period and depending on the type of bond, it may range from a couple of months to a couple of years. Thus the total return that is generated after the maturation period is the Yield to Maturity.
Current yield is the rate of return that is obtained at the current moment when the bond is sold. The current yield value is used as a means to assess the current price of the bond in the market and the yearly rate of return of the bond.
Comparison Table Between YTM and Current Yield
| Parameters of Comparison | YTM | Current Yield |
| Definition | Yield to Maturity is the rate of return that is obtained after the maturity period of the bond | Current yield is the return that is generated at the current moment when the bond is sold |
| Objective | It determines the total return on investment for the bond | It is used as a measurement to assess the relationship between the current market price of the bond and the yearly return |
| Calculation | There are many parameters used for calculating the YTM, such as the current yield, business profit, etc | The current yield is calculated by dividing the annual interest payment of the bond by the current market price of the bond |
| Bond Purchase | If a bond is bought at a discount to the actual value, the YTM increases | If a bond is bought at a discount, the Current Value decreases |
| Reinvestment | Reinvestment risks depend on the YTM of the previous maturity period | Reinvestment risks are not accounted in the Current Yield |
What is YTM?
Yield to Maturity (YTM) is the rate of return on a bond that is obtained after the maturity period of the bond. It determines the total return on investment of the bond which is generated after the maturity period of the bond. YTM, Book yield, redemption yield all mean the same. It is a theoretical value associated with a bond which is an internal rate of return earned by an investor after the maturity of the bond.
The yield measurements are made considering some assumptions such as the bond is held until maturity, all the investment payments are made on schedule, and that the returns received will be reinvested into the bond in the next tenure. Many parameters are taken into account while determining the actual value of the bond. But the general formula that can be used for calculating YTM is as follows:
YTM = {Annual Interest Payment) + [(Face Value – Current Value of the bond)/Remaining maturity period]} / [(Value of the bond + Current price) / 2]
This gives a fair estimate of the value of the bond. Although the value is theoretical, as the bonds usually enjoy a slow incline in value, the value is reliable and very close to the practical value.
What is Current Yield?
The Current Yield of a bond is the value that is returned by the bond at the current moment when the bond is sold. It is the price of the bond that the market is ready to pay to buy the bond. The current yield is used as a measurement for assessing the relationship between the current market price of the bond and the yearly return to the bond.
The bond prices move opposite to the interest rates and hence, the prices decrease when the interest rates increase. Thus when the interest provided by a bind in the market is more, the current price of the bond will decrease. Thus to sell the bond, the current price must be made so that it balances out with the interest rate to obtain a better current yield. A simple formula is used for calculating the current yield of a bond.
The current yield of the bond is obtained by dividing the annual interest payment of the bond by the current market price of the bond. The price of the purchase of a bond affects the current yield. If a bond is purchased at a discounted rate to the actual market value, then the current yield will decrease.
Main Differences Between YTM and Current Yield
- YTM is the return rate that is obtained after the maturity time of a bond. Current yield is the current return which is obtained when the bond is sold.
- YTM determines the total return on investment of the bond. Current yield is used as a measurement for assessing the relationship between the current market rate and the yearly return.
- There are many parameters used to calculate the YTM of a bond and current is one of the parameters. The Current Yield is calculated by dividing the annual interest to the current price of the bond.
- The YTM increases if a bond is bought at a discount to the actual value. The Current Yield increases if the bond is bought at a premium value.
- Reinvestment risks depend on the YTM of the previous tenure. Reinvestment is not accounted in Current Yield.
Conclusion
Bonds and stocks have fundamental differences in the way they work. Both are asset classes but the method of generation of funds is different.
Bonds are usually issued by government agencies and subsidiaries owned by the government. Every bond has a maturity period which could range from a couple of months to a few years.
The maturity period is the amount of time the bond will take to generate the theoretical book yield, which is known as the Yield on Maturity (YTM).
On the other hand, the Current Yield is the yield that will be obtained on selling the bond right now.
References
- https://journal.unnes.ac.id/sju/index.php/aaj/article/view/1152
- https://scholar.archive.org/work/dkb5mawrvfaxzcvyz7cpj3dspu/access/wayback/http://www.cya.unam.mx/index.php/cya/article/download/2688/1559
- https://www.jstor.org/stable/3665667
- https://www.tandfonline.com/doi/pdf/10.2469/faj.v47.n4.52