The term “yield” is used to gauge an investment’s cash flow over the tenure of the investment.
In stocks, the yield means the return earned on the dividend by the stockholder. However, the profit from the shares’ sale is not included. The formula for yield on stocks is –
(Price increase + Dividend Paid)/Price
In bonds, the yield or normal yield is the returns earned on the interest, also known as the coupon rate. The bond yield is also known as the annual return that is earned from investing in fixed income securities. Therefore, the formula of normal yield is –
Annual interest earned/Face value of the bond
When a bond is held until maturity, the total expected returns are referred to as yield to maturity. All the present values of an investment’s future cash flow should be considered while calculating the YTM. These cash flows are equal to the current market price. However, it is assumed that the earnings from the investment are reinvested at a constant rate, and that the investor holds the investment until maturity.
The investor knows the bond’s price, the coupon payments as well as the maturity value. It is the discount rate, which is the yield to maturity, that has to be calculated. The formula for calculating YTM is as given below:
YTM= √(n(Face Value)/(Current Price)-1)
where, n refers to the tenure until maturity, Face Value = the maturity value of the bond and the Current Price is the bond’s current price.
It is possible to calculate the yield to maturity only through empirical methods, also known as trial and error.