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What is the difference between nominal yield and yield to maturity?

Curious about private banking

What is the difference between nominal yield and yield to maturity?

In the context of fixed income securities, the nominal yield and yield to maturity are two different measures that investors use to assess the return on their investments. Here's an explanation of each:

1. Nominal Yield: The nominal yield, also known as the coupon rate, is the annual interest rate that a bond pays relative to its face value. It is expressed as a percentage. For example, if a bond has a face value of INR 10,000 and a nominal yield of 5%, it will pay an annual interest of INR 500.

2. Yield to Maturity (YTM): The yield to maturity represents the total return an investor can expect to receive from a bond if they hold it until it matures. It takes into account not only the coupon payments but also any capital gains or losses resulting from the difference between the purchase price and the face value at maturity. YTM is expressed as an annualized percentage.

The key difference between nominal yield and yield to maturity is that the nominal yield only considers the annual interest payments, while the yield to maturity factors in the bond's price and the length of time until it matures. YTM provides a more comprehensive measure of the bond's potential return, as it considers both the interest income and the potential capital gain or loss.

It's important for investors to consider both the nominal yield and yield to maturity when evaluating fixed income investments. The nominal yield helps assess the income generated by the bond, while the yield to maturity provides a more comprehensive view of the total return over the investment period.

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