provide To Maturity – Bond provide
Bonds are quoted based on several indicators. Price, coupon rate (moderate provide), call provide (if callable) and provide to maturity. Each of these will effect the value of the investment. The provide to maturity is the overall rate of return, over the life of the bond based on many of the factors above.
A fixed income security is sold based on current interest rates vs. the interest rate on the bond. This difference is why bonds are sold at premiums (above par) and at a discount (below par). If a security has a moderate provide of 6%, but current interest rates on similar bonds are at 5% – the bond will be priced at a premium. This will consequence in a lower provide to maturity than the moderate rate of 6%.
Because bonds are fixed securities, the 6% rate cannot be changed, consequently brokers and traders will re-price bonds to mirror the current interest rate ecosystem. Since interest rates are at 5%, the bond will be priced to provide near 5%. The fixed coupon is paid to par value only. So, based on one bond ($1,000 par), the investor will earn $60 per year in interest – in spite of of the price paid for the bond. The premium never earns interest. The customer will also only get par at maturity. The provide to maturity will be lower because they are investing over par for the bond, but only getting interest on par and getting par at maturity. That loss of premium price over the life of the bond, coupled with the interest will give the bondholder a lower overall YTM at the end.
Fixed income bonds sold at discounts will have the opposite effect on provide to maturity. Since discount securities have a lower coupon rate than current interest rates, the provide to maturity will be higher than the moderate rate. If a bond is at 5% is sold at $950, the YTM will be greater than 5% because the investor is earning 5% on $1000, when he only invested $950 and he will get $1000 at maturity. The provide grows because of the coupon earned and the accreted discount of $50 earned throughout the life of the investment.
Debt bought at par will have a YTM equal to the moderate provide because no premium or discount was paid. A 6% security bought at par will provide 6%.
Bonds that are callable can be lower or higher than the YTM based on the call price that the security is redeemed early at and the time of the call event or date. Typically, fixed income investments that are bought at a premium will have a lower provide to call, because the premium cost is lost sooner. A discount debt instrument will typically have a higher provide to call, since the discount gain is paid off to the investor sooner – and prior to maturity.