Running head: Yield to Maturity
Yield to Maturity
Yield to Maturity
The financial assets are valued by factors that influences the demand investor ask for in return. These valuations of financial asset are determined by the present value of future cash flows. The price, or current value, of a bond is equal to the present value of interest payments over the life of the bond plus the present value of the principal payment at maturity. The yield to maturity, or discount rate, is the rate of return required by bond holders. There are three factors that can influence the investors required rate of return which are real rate return, inflation premium and risk premium (Block and Hirt, 2005).
The 10 % bond is the face value of the bond, compared to the other factors that contribute to its actual value which is 9 % yield to its maturity. During the time period of maturity the bond will be receiving a 10 % return on the face value on every interest payment date. The real rate of return is the rate of return the investor demands for giving up the current use of the funds base on noninflation adjusted basis (Block and Hirt, 2005). Another factor that influences the return rate is inflation premium. This is when the investor requires a premium to compensate for the effect of inflation through supply and demand and the timing of purchase on the value of the dollar. Combining the real rate of return and inflation premium the risk free rate is determined. This allows the investor to be compensated for the current use of their funds and the loss in purchasing power due to inflation (Block and Hirt, 2005).
The risk premium includes the rate of return, where it is added to the risk free rate of return. This premium is associated with two types of risk: Business and Financial risk. The risk premium will tend to be greater or less depending on the types of investments which include discounts or other premiums that is paid on that particular bond (Block and Hirt,...