How to Calculate YTM in Excel

If you’re interested in investing in bonds, then you need to know how to calculate Yield to Maturity (YTM) – the most accurate estimate of a bond’s expected return. YTM is the rate of return you can expect if you keep a bond until maturity and reinvest all the interest payments at the same rate. While YTM can be calculated by hand, using Microsoft Excel can simplify the process and save you time. In this blog post, we’ll show you how to calculate YTM in Excel step-by-step.

Understanding YTM

Before we dive into the calculations, let’s review Yield to Maturity (YTM). It’s the total return anticipated on a bond if it’s held until maturity. In other words, it’s the annual return you’ll make if you receive all payments on a bond and participate in compound interest. Unlike other yield measures, such as current yield and yield to call, YTM considers a bond’s interest rate, face value, maturity, and purchase price.

Step-by-Step Guide for Calculating YTM

Now, let’s take a look at how to calculate YTM in Excel.

Step 1: Gather Bond Information

First, you’ll need to collect essential information about the bond, including:

• Face value
• Coupon rate
• Maturity date
• Purchase price or current market price

Step 2: Set Up the Excel Spreadsheet

Next, you’ll need to set up your spreadsheet to calculate YTM. Create the following columns:

• Period
• Cash flow
• Present value

Step 3: Calculate Cash Flow

The next step is to calculate the cash flow for each period. To do this, multiply the periodic coupon payment by the face value of the bond. In the final period, add the principal value to the coupon payment.

Step 4: Calculate the Yearly Discount Rate

You’ll now need to calculate the yearly discount rate. This reflects the expected return on the bond. In the Excel sheet, use the RATE function to determine the yearly discount rate using the following inputs, where C is the cash flow, FV is the face value, N is the number of periods, and P is the purchase price.

=RATE(N,-C1:Cn,FV,P)

Step 5: Calculate the Present Value

Finally, use the PV function to calculate the present value. This function calculates the current value of an annuity or lump sum payment. For each period, multiply the cash flow by the present value factor using the yearly discount rate.

=PV(yearly discount rate, period number, periodic coupon payment, bond price)

Step 6: Calculate YTM

With your Excel sheet set up, calculating YTM is straightforward. You’ll need to use the following formula:

=YTM(N,C1:Cn,P,FV)

Where N is the number of periods, C1:Cn is the range of cash flows, P is the purchase price, and FV is the face value.

Final Thoughts

Calculating YTM in Excel is a simple process that can save you time in determining your bond’s expected return. With these steps, you’ll be able to calculate YTM and make informed decisions about your investments.

Excel Functions to Use When Calculating YTM

In addition to the steps above, there are a few other Excel functions that can be useful when calculating YTM:

• DMY: This function specifies the date system Excel uses to interpret date-based functions. Ensure that it’s set to 1 and correctly formatted for your region.
• PRICE: This function calculates the price of a bond per unit of face value.
• DURATION: This function calculates the Macaulay Duration of a bond.

Other Factors to Consider When Calculating YTM

While YTM is an essential measure of bond returns, there are a few other things to consider when looking at your portfolio’s performance:

• Inflation: Inflation can significantly impact bond returns. Investors should keep the inflation rate in mind and adjust their bond investments accordingly.
• Risk: While bonds are generally considered a safer investment option, they aren’t entirely without risk. Investors should pay attention to credit ratings and the bond issuer’s financial health to assess their risk profile.
• Diversification: As with any investment, diversification is key. Investors should consider investing in a variety of bonds with varying maturities, coupon rates, and issuers.

Yield to Maturity is a vital metric for investors looking to purchase bonds, enabling them to assess a bond’s expected return. By calculating YTM in Excel, investors can simplify the process and make informed investment decisions. Use the steps outlined in this post to calculate YTM for your bond portfolio and keep other factors, such as inflation, risk, and diversification, in mind to create a well-rounded investment strategy.

FAQs

Here are some frequently asked questions about calculating YTM in Excel:

What is the benefit of calculating YTM in Excel?

Calculating YTM in Excel is quicker and more efficient than calculating it by hand. It also allows you to perform sensitivity analyses by changing inputs and immediately seeing the resulting YTM.

What is the difference between YTM and current yield?

Current yield measures the return a bond will generate in the coming year, based on its current trading price and annual coupon. YTM, on the other hand, accounts for cash flows across the bond’s entire life and is a more accurate representation of a bond’s yield.

What is the significance of using the yearly discount rate?

The yearly discount rate is significant because it considers the time value of money. If you keep a bond until maturity, it will generate compound interest, which the yearly discount rate accounts for. It’s also a required input when using the PV function to calculate the present value of future cash flows.

What happens to YTM when bond prices change?

YTM will change as bond prices change. When bond prices increase, YTM decreases, and vice versa. This is because the yield is calculated as a function of the periodic coupon payment and the purchase price.

Is YTM the same as an investment’s rate of return?

While YTM is an essential component of calculating an investment’s rate of return, it doesn’t account for other factors such as reinvestment risk, inflation, and taxes. Therefore, the total rate of return an investment provides will typically be different from its YTM.