Calculating yield to maturity under the "rule of thumb" method is not difficult. The concept with it is the YTM is based on the Nominal Yield, Price and the years to maturity. So, the formula or calculation is based on that.
Premium bonds have a lower yield to maturity vs. the nominal rate. That is because the nominal yield only pays to par value. Thus if the bond was bought above par, the premium amount does not earn interest and the premium is not paid at maturity. The investor is losing the above par amount at the end of the term. If the investment was sold beforehand at a profit - the cost would be a profit.
Example
A 5% bond was purchased at $1150 and the maturity is 15 years. Calculating YTM would be based on all of this information. The total premium amount is $150 - divided over 15 years would give you $10 per year. That is the amount that is basically lost each year on the price - if held to maturity.
The way the formula is calculated is you take the yearly real interest - which is $50 and then subtract the lost above par yearly price of $10. This leaves you with a real yearly return of $40. Then divide $40 by the average price of the bond during it's life. Since par ($1000) is the redemption price and $1150 was the price that was paid - the median price would be $1075.
So $40 divided by $1075 would be the YTM = 3.72%
Discount bonds are calculated the same way - except the yearly discount is added on to the nominal interest payments. This would result in a higher YTM calculation.
http://www.aitraining.com/ytm.htm
Premium bonds have a lower yield to maturity vs. the nominal rate. That is because the nominal yield only pays to par value. Thus if the bond was bought above par, the premium amount does not earn interest and the premium is not paid at maturity. The investor is losing the above par amount at the end of the term. If the investment was sold beforehand at a profit - the cost would be a profit.
Example
A 5% bond was purchased at $1150 and the maturity is 15 years. Calculating YTM would be based on all of this information. The total premium amount is $150 - divided over 15 years would give you $10 per year. That is the amount that is basically lost each year on the price - if held to maturity.
The way the formula is calculated is you take the yearly real interest - which is $50 and then subtract the lost above par yearly price of $10. This leaves you with a real yearly return of $40. Then divide $40 by the average price of the bond during it's life. Since par ($1000) is the redemption price and $1150 was the price that was paid - the median price would be $1075.
So $40 divided by $1075 would be the YTM = 3.72%
Discount bonds are calculated the same way - except the yearly discount is added on to the nominal interest payments. This would result in a higher YTM calculation.
http://www.aitraining.com/ytm.htm
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