The Yield to maturity (YTM) or redemption yield of a bond or other fixed-interest security, such

as gilts, is the internal rate of return (IRR, overall interest rate) earned by an investor who buys
the bond today at the market price, assuming that the bond will be held until maturity, and that
all coupon and principal payments will be made on schedule. Yield to maturity is actually an
estimation of future return, as the rate at which coupon payments can be reinvested when
received is unknown.[1] It enables investors to compare the merits of different financial
instruments. The YTM is often given in terms of Annual Percentage Rate (A.P.R.), but more
usually market convention is followed: in a number of major markets the convention is to quote
yields semi-annually (see compound interest: thus, for example, an annual effective yield of
10.25% would be quoted as 5.00%, because 1.05 x 1.05 = 1.1025).

The yield is usually quoted without making any allowance for tax paid by the investor on the
return, and is then known as "gross redemption yield". It also does not make any allowance for
the dealing costs incurred by the purchaser (or seller).

 If the yield to maturity for a bond is less than the bond's coupon rate, then the (clean)
market value of the bond is greater than the par value (and vice versa).
 If a bond's coupon rate is less than its YTM, then the bond is selling at a discount.
 If a bond's coupon rate is more than its YTM, then the bond is selling at a premium.
 If a bond's coupon rate is equal to its YTM, then the bond is selling at par.

What Does Yield To Maturity - YTM Mean?

The rate of return anticipated on a bond if it is held until the maturity date. YTM is considered a
long-term bond yield expressed as an annual rate. The calculation of YTM takes into account the
current market price, par value, coupon interest rate and time to maturity. It is also assumed that
all coupons are reinvested at the same rate. Sometimes this is simply referred to as "yield" for
short.
Definition of Cost of Capital a) Definition and Regulatory Objectives
• Cost of capital is a measure of the financial return that investors seek for the risk
they are taking on by investing in the company

• Regulatory objectives

o Provide sufficient return to encourage investments

o Refer to capital market performance where it is possible

o Consider adequately the risk of regulated industry

o Provide incentives to employ optimal capital structure (minimal cost of

capital)

Definition of Cost of Capital c) Cost of Debt

• Calculated as sum of the risk free rate and debt risk premium (debt spread)
 • Availability of market data essential

• Risk free rate

o Is the expected return on an asset which bears no risk at all, no default

risk

o Estimated on the basis of appropriate long-term government bond yields

• Debt risk premium

o Is the interest paid on corporate bonds over and above a comparable risk-
free bond

o Can be obtained by observing published credit ratings that specialist

credit rating agencies assign to the company

Definition of Cost of Capital d) Cost of Equity (1)

• Calculated as sum of the risk free rate and equity risk premium adjusted by beta
coefficient

• Availability of market data essential

• Risk free rate

o Is the expected return on an asset which bears no risk at all

o Estimated on the basis of appropriate long-term government bond yields

• Beta coefficient

o Is an attempt to examine how the return on the investment co-varies with

the return on the market portfolio

o Direct estimates are not possible unless a company is publicly traded

o An estimate of a company’s equity beta can be calculated from an

estimate of its asset beta (based on international experience)

• Equity risk premium

Quantification of Cost of Capital a) Capital Asset Pricing Model (CAPM)

• The most common model applied in practice (also for regulatory purposes) to
determine a theoretically appropriate required rate of return of an asset

• Discussion in finance about the theoretically exact model, but to date CAPM remains
the basic model that provides a fairly good representation (rough proxy) of the real world

• Total risk of portfolio = specific risk + systematic risk

o specific (unsystematic) risk

 components uncorrelated with general market movements

 company specific individual risk, can be diversified away by

investing in the market
 o systematic risk

 common to all assets in the market (market risk)

 risk for being in the market

 cannot be reduced by diversification

• stock owners only compensated for systematic risk◊

Quantification of Cost of Capital d) Dividend Growth Model (DGM)

• The Dividend Growth Model (DGM) or Dividend Discount Model values a stock with
the present value of the dividend stream from that stock

• Requires forecasting of the future distribution of dividends

• The company growth regarded as constant (in one stage specification of the model)

• Usually used as supporting model to examine the accuracy of the CAPM results

R e = + g D 1 P 0 Cost of Equity expected dividend current share price rate of growth in dividend
Definition of

YTM
Stockholding & Investments
investor's total return if security held to maturityyield to maturity: the total return to an investor if a fixed
interest security is held to maturity, in other words, the aggregate of gross interest received and the capital
gain or loss at redemption, annualized.