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Measure content performance. Develop and improve products. List of Partners vendors. When investors consider buying bonds they need to look at two vital pieces of information: the yield to maturity YTM and the coupon rate. Investment-quality bonds are low-risk investments that generally offer a rate of return slightly higher than a standard savings account.
They are fixed-income investments that many investors use for a steady stream of income in retirement. Investors of any age may add some bonds to a portfolio to lower its overall risk profile.
Generally, a bond investor is more likely to base a decision on an instrument's coupon rate. A bond trader is more likely to consider its yield to maturity. The YTM is an estimated rate of return. It assumes that the buyer of the bond will hold it until its maturity date, and will reinvest each interest payment at the same interest rate.
Thus, yield to maturity includes the coupon rate within its calculation. YTM is also known as the redemption yield. A bond's yield can be expressed as the effective rate of return based on the actual market value of the bond. At face value, when the bond is first issued, the coupon rate and the yield are usually exactly the same. However, as interest rates rise or fall, the coupon rate offered by the government or corporation may be higher or lower.
Changes in interest rates will cause the market value of the bond to change as buyers and sellers find the yield offered more or less attractive under new interest rate conditions. In this way, yield and bond price are inversely proportional and move in opposite directions.
The coupon rate or yield is the amount that investors can expect to receive in income as they hold the bond. The bond prices for these interest rates are INR Since the current price of the bond is INR Yield to Maturity is a return metric for Debt Funds. However, it fluctuates with changing market conditions. Furthermore, since debt funds invest in multiple funds, a change in the YTM of a single bond will have an impact on the YTM of the debt fund.
However, the magnitude of this change will be proportionate to the weightage of the bond in the debt mutual fund portfolio. As a result, the market value of the bond is now INR Based on the changes, the details of the corporate bond after one year shown below:. After one year, the YTM of the bond is Hence changing market conditions like inflation, interest rate changes, downgrades etc affect the YTM. An increase in YTM of the bond due to change in market conditions indicates the bond or debt fund is of low quality.
Whereas, a decrease in the YTM due to change in market conditions shows the bond or debt fund is of high quality. Yield to Maturity helps in only determining the potential returns of a debt mutual fund. However, it also gives a fair idea of the risks associated with the investments.
For example, a debt fund having a high YTM means that the scheme has substantial investments in bonds with low credit ratings. Bonds with low credit ratings offer higher coupon rates in comparison to bonds with higher credit ratings. However, it is important to note that these bonds have a downside as well. Low credit rating bonds have a greater level of credit and liquidity risk.
Credit risk is when the bond issuer defaults on interest payments. At the same time, liquidity risk is when the fund manager is unable to exit their position on the bond quickly. Therefore, while investing in debt funds, one should consider their risk profile. High-risk investors can consider investing in debt funds with higher YTM to generate greater returns.
While low-risk investors can opt for funds with lower YTM that invest primarily in bonds with high credit rating. YTM of debt funds changes over time. However, one can estimate their future returns from Debt investments. Estimating the future returns helps in many ways, such as how much one should invest to reach their target amount, pay for a future expense, etc. The calculations are only an estimate of potential returns and do not guarantee any returns. To compute the potential future returns, one should know the following details of a fund:.
The anticipated interest rate change is 0. Now, instead of a decrease in interest rate, if there is an increase 0.
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