Yield to maturity (YTM) is one of the most important numbers to look at when it comes to evaluating the long-term return on a debt-based investment (such as Notes on Mintos or bonds). It’s expressed as an annual rate of return and is calculated under the following assumptions:
- The investment is held until maturity.
- The investment is made at the listed rate (including any premium or discount).
- Future payments will be made on time.
- If the asset has late payments, they will be received the next day.
Why YTM is important
The yield to maturity represents the current value of all future cash flows from an investment. Regardless of the remaining term, it’s expressed as an annual rate, making it a useful tool for investors to compare the expected return on investments with different interest rates and maturities, especially if they are sold at a discount or premium.
The YTM has an inverse relationship with the investment price. That means:
The YTM for a loan sold at par will be identical to the nominal interest rate
The YTM for a loan with a discount will be higher than the nominal interest rate
The YTM for a loan with a premium will be lower than the nominal interest rate
How to calculate YTM
To calculate the yield to maturity, we need to know the current price of the investment and the future cash flows. The precise calculation is a bit more involved and depends on how the loan amortizes.
The following generalized formula is used to calculate YTM:
P = price at which the investment is listed, including any premiums or discounts
n = payment period which takes values from 0 to the ending period of scheduled payments (nth period)
Cn = scheduled payment (principal and interest) in the nth period
YTM = the yield-to-maturity of the investment
The yield to maturity can also be calculated using the XIRR (Extended Internal Rate of Return) formula in Excel by plugging in the scheduled dates and payments. For investments in loans on Mintos, this information can be found in the loan details.
Limitations of YTM
YTM calculations make assumptions about the future that can’t be known in advance. For example, the investor might decide to sell the investment early, or the borrower might default on the loan. In such cases, the realized return might be different from the calculated YTM. The YTM also doesn’t account for taxes or fees.