What does yield to maturity approximate method represent?

• A. It represents the current yield only.
• B. It is the expected annual return if the bond is held to maturity and includes price changes.
• C. It is the coupon rate.
• D. It is the price today.

Answer: (B)

Yield to maturity approximates the expected annual return if you hold the bond to its maturity, including both the coupon payments and the price change you’ll realize when the bond matures at par. It’s essentially the return you’d earn as an internal rate of return, assuming you keep the bond to maturity and reinvest the coupons at the same rate. This differs from the current yield, which looks only at the annual coupon relative to the current price and ignores what happens at redemption. It’s not the fixed coupon rate, which is set as a percentage of par, nor is it simply the price today. The approximate method uses a simple formula to provide a quick estimate by tying together the annual coupon, the difference between par and price, and the years to maturity. For example, a bond with par 1000, annual coupon 50, price 950, and 10 years to maturity would yield an approximate return around 5–6%, reflecting both the coupon and the small gain at redemption.