The yield to maturity refers to how much a security will earn if it is held to its maturity date. It is the annualised return based on all coupon payments plus face value if you hold the security until maturity or the market price if it was purchased in the secondary market. It includes any gain or loss if the purchase price was below or above the face value. For this reason, the yield to maturity is considered the most important variable of bond analysis because it provides a basis for comparison between different securities and other interest rate based products.
Examples
GE Capital fixed rate bonds have a nominal yield or coupon of 6% and a maturity of 15 March 2019 are currently trading at a discount to face value at around $87.27 (face value is $100). If we calculate yield to maturity we find yield to maturity is 8.0% and is higher than the coupon rate of 6%. This means that the effective return over the life of the security is 8% once the discounted market price is taken into account.
St George Bank fixed rate bonds have a nominal yield or coupon of 10% and a maturity of 9 May 2018 are currently trading at a premium to face value of $108.40 (face value is $100). If we calculate yield to maturity we find yield to maturity is 7.0% and is lower than the coupon rate of 10%. The effective return over the life of the security is 7% once the higher than face value purchase price is taken into account.