This is a bond's total rate of return during the full life of the investment. The yield to maturity factors in the nominal rate or coupon, the price paid and the length of the maturity.
The YTM is the most important yield indicator for a bond investment. It factors in the nominal yield, bond price and length of maturity held.
When investors buy bonds, the coupon rate is important, but if the bond price is higher than par - the yield to maturity will be lower. If the bond is bought at a discount, the yield to maturity will be higher.
The nominal yield (coupon) is a fixed rate that is only paid to par value. All bonds redeem at par as well. So, if the investment is purchased below or above par, the yield will be different.
The YTM is actually the current interest rate on a particular bond or similar bonds. If a 7% bond is availale, but interest rates are actually only 5%, the broker or the market will price that bond higher (premium) - to reflect the current interest rate environment. The broker is not going to sell a 7% bond at par when interest rates are 200 basis points lower. A premium will be the market.
If the interest rate climate on these bonds is 5%, the security will be priced for a yield to maturity of around 5%. So, the investor is really getting a 5% overall rate of return on this bond, if held to maturity - even though the nominal yield is 7%. Interest is never paid to a premium or discount. It is only paid to par.
From American Investment Training. More on the link below
Bond Yield
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