ShmoopTube

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finance a la shmoop what is yield to maturity yield it's the dough you get

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back from your investment in a bond here's a thousand-dollar bond here's the [pigeons sitting on a line]

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coupon of 7% so the yield is 7% while the bond lasts for 10 years and then

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after paying you 70 bucks a year for a fat and happy decade of sitting on your

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Duff collecting your interest you get your grand back and well that's it right [check changes hands]

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um no well what happens if you bought that bond for nine hundred bucks or

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twelve hundred bucks or some other random amount yeah way more complex well

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there are two ways you make money from investing in a bond first there's the

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interest as we just outlined 70 bucks a year the semi annual festival of dances [people dancing together]

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when the interest payment is made right it's 35 bucks twice a year easy but then

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there's the appreciation of the principle of the bond and yeah it could [flying crow starts inflating]

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be depreciation of it - all right you bought a 6% yielding bond at a discount

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to its thousand-dollar par value like say you paid 92 cents on the dollar nine

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hundred twenty bucks for a thousand dollar par value bond well over ten

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years you hold that bond until it matures it will appreciate in value I

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call it - eight bucks a year and then it will pay to investors that thousand [check change hands]

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dollar par value well yield to maturity which doesn't apply to shmoop writers

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takes into account both sets of cash flows into your wallet the interest

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yield plus the appreciation of the principle of the bond so in this case

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the bond was paying interest of 60 bucks a year but then it also had appreciation

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of eight bucks a year for a total of 6.8%

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or 68 bucks a year in appreciation all right is this all there is to it you

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just throw in a straight line number therefore the annual appreciation eight

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bucks every year smoothly that's of the principle until it hits par and then

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you're done no not at all life is never that simple all kinds of curveballs will

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be thrown at you all over your head there and you think about you to [flying bird dodging balls]

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maturity okay here's one for starters what about the time value of money

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remember that thing ie the cash that you get twice a year in bond interest well

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couldn't you reinvest that money elsewhere like it

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moment the moment you collected 10 years earlier before bond matures and make

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more money well sure you could and what about the application of straight-line

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depreciation to the gain of 80 bucks over 10 years like why does the bond

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depreciate exactly eight dollars a year in value instead of Raoh maybe less in

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the early years and more in the later or or vice versa

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yeah lots of curveballs and some of these are just accounting decisions or [businessman studying papers]

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the way things are done and the way things are done in bond land is usually

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driven largely by the way the IRS wants to tax you got it so that whole [Uncle Sam walking down the street]

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straight-line depreciation thing and that's largely an IRS driver and here's

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another some bonds are callable early so what if this bond was callable after

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five years but at 102 or a $20.00 premium per bond or a thousand twenty

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well then yeah the yield calculation is different and it's normally called out

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as a quote yield to worst unquote or rather yield to the worst possible

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outcome of the bond other than it going bankrupt or you know not paying on time [coins dropping]

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in this case the yield to worst would be an appreciation from nine twenty two a

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thousand twenty or a gain of a hundred bucks then over just five years so you'd

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add twenty bucks a year to the dividends of sixty bucks a year and you'd get a

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well at least a notional yield here then of eight percent right if the bonds were

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in fact called at ten twenty thousand twenty bucks each got at eight percent

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or does that yield to worst is that the worst you knuth know it's not the worst

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at all the normal trajectory of this bond has it maturing in a decade and at

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par not at a premium to par that ten twenty thing so it isn't bad to be a

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yield to Wurster in this case it's just that if the bond is called early well [crow flying]

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that would be the worst it would do other than like you know not pay off or

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go bust and obviously this is all about appreciation when you buy it

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depreciation you know works the same so just relist into this video in Reverse

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and sometimes worst ain't so bad you [two birds on a line]

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