Yield to maturity is defined as the rate of return earned from interest and principal payments with compounded interest twice in a year at the yield stated with assumption that the security kept until the maturity date. Amount of discount and premium at the time of purchase is considered into account for yield of premium, if any and the time of investment value.
Internal rate of return calculation is similar to Yield to maturity calculation. The bond is selling at a discount mean the current yield is less than its yield to maturity. If the bond is selling at a premium mean the yield is more than yield to maturity. If the bond is selling at equal, then the yield is equal to yield to maturity.
Most of the bonds are designated in $1000 out of which a percentage of that is paid by investor. Investor has to pay $900 if the bond at 90 for every $1000 bond. Investor has to pay $1200 for every $1000 bond if the bond value is $120.
Bond that was purchased at discount will have yield to maturity that is higher than the current yield. However bond purchased at a premium price will have a yield to maturity lower than the coupon yield. Interest is paid in arrears by bonds, in other words interest is paid by bonds only after it’s earned. If $10000 bond pays interest in july and January, investor is compensated with interest payment for July with the issuer money until January through previous july. Investor earns the interest every day through the owning period even through interest is paid in arrears for bonds. At the time of sell, the investor is entitled earn interest that earned but not received yet.
Conclusion
Yield to maturity is important to customer as yield to customer must be quoted on every bond.
Yield to maturity is actual yield for the bond taking into account the price investor pay as percentage of face value plus the interest payment received.
References
Block Stanley, Hirt Geoffrey, Foundations of Financial Management, The McGraw...