Yield Measurements

Current yield
= Annual coupon / Price

Problem: do NOT consider capital gain/ loss or reinvestment income

Yield to maturity (YTM)
IRR of an investment in the bond that equates the PV of all expected cash flows from bond to its full price.

At par, nominal yield(coupon) = current yield = YTM
At discount, nominal yield(coupon) smaller than current yield smaller than YTM
At premium, nominal yield(coupon) greater than current yield greater than YTM

Note:
· for semiannual bond, IRR is not YTM which is equal to BEY

Assumptions and limitations of YTM:
· Security will be held to maturity
· All intermediate cash flows will be reinvested at the same rate as yield. Higher term to maturity leads to higher reinvestment risk. Higher coupon rate implies higher reinvestment risk.
· All coupon payment are received promptly & timely fashion, ie no credit risk. So YTM is also referred to as promise yield.
· A flat yield curve (rarely exist)

Bond-equivalent yield (BEY)
· Discount rate calculated using six-monthly periods and annualized by multiplying by two.

Realized return (annualized basis) = YTM =BEY

Equivalent annual yield (EAY) = (1+YTM/2) ² for semiannually paid bond

Yield to call
Value bond on the basis that it will be called on first call date. Market conversion is to use the lower /more convervative measure of yield (YTM or YTC) as the appropariate indicator of value.

For premium bond, YTC smaller than YTM
For discount bond, YTM smaller than YTC


Yield to put

Yield to worst(YTW)
The lowest expected return among YTC, YTP, YTM etc.

Cash flow yield (CFY)
Based on the cash flows that include an assumption regarding prepayment rate. Useful for MBS that have monthly payments. The estimated rate of principal repayment may be different from the actual rate of prepayment.

EAY= (1 + Monthly CFY)¹² - 1