The calculation of current yield and yield to maturity on the investment in a bond or other fixed income instrument tells an investor whether to sell the bond early or hold it until it matures. Both calculations tell the investor the rate of return on the investment at specific points in time. If the yield to maturity is less than the current yield, the bond would sell at a price that is greater than its face value. In that instance, the investor might want to sell the investment, rather than hold onto it. Conversely, an investor would likely want to hold onto a bond with a yield to maturity that is greater than the currently yield.
Bonds are loan instruments that corporations, governments and certain other entities issue to raise money. Unlike stock, bonds pay a fixed amount of interest while the bond is outstanding and must be repaid in full by the corporation at the end of the loan term. The date the bond must be repaid is its maturity date.
Investment return on bonds is not simply a matter of how much interest it pays over the life of the loan. Even though bonds have a face value, or how much the issuing entity will repay when the bond is redeemed at its maturity, they are very rarely sold to the public for that amount. Bonds are typically sold at a discount or at a premium, which means that they sell for less than or more than their face value.
The calculation of current yield determines the bond's annual rate of return. Yield to maturity calculates the rate of return if the bond were held to maturity. Evaluating current yield and yield to maturity enables an investor to determine the best course of action when dealing with the investment. This analysis takes into account whether the bond was purchased at a discount or premium and whether it can be resold at a discount or premium.
Differences in the sale price of the bond versus its face value make the comparison between current yield and yield to maturity particularly insightful. A bond that is selling now at a price that is much less than its face value means that the person who holds it to maturity will get an additional payment. He will receive the face value, even though he paid less than that to buy the bond. This additional benefit becomes part of the return on investment if it is held to maturity.
Conversely, current yield and yield to maturity analysis might support a decision to sell the investment if the holder can sell it for a premium, or more than the face value. In this instance, the possible current yield would have to be considered a loss to the investor if the bond is held to maturity. The issuing entity will only pay the investor the face value of the bond at maturity, even though he could have sold it for more money in the past.
