- 1). Purchase a bond at a price lower than its valuation. Suppose a bond with a face, or par, value of $1,000 pays 5 percent interest or $50, has one year to maturity, and the current market yield is 6 percent. The bond is then valued at $50/(1 + 6 percent) + $1,000/(1 + 6 percent) = $990.56. Because of market imbalance of supply and demand, an investor is able to purchase the bond for $980, lower than the valuation price, and thus YTM can be solved through the equation $980(1+YTM) = $50 + $1,000 and YTM = $1,050/$980 - 1 = 7.14 percent. Yield to maturity is increased from 6 percent to 7.14 percent.
- 2). Choose a bond with a higher coupon rate. Suppose another bond pays 5.5% in coupon rate and the valuation price of the bond is $55/(1 + 6 percent) + $1,000/(1 + 6 percent) = $995.28. If an investor is able to buy the bond for $993, YTM is solved as follows: $993(1 + YTM) = $55 + $1,000 and YTM = $1,055/$993 - 1 = 6.24 percent. Yield to maturity is increased from 6 percent to 6.24 percent.
- 3). Find a bond with less time to maturity. Suppose another bond has two years to maturity and a value of $50/(1 + 6 percent)(1 + 6 percent) + $50/(1 + 6 percent) + $1,000/(1 + 6 percent)(1 + 6 percent) = $981.67. If an investor paid $985 to still buy the first bond with one year to maturity, YTM is $985(1 + YTM) = $50 + $1,000, that is, YTM = $1,050/$985 - 1 = 6.6 percent. Yield to maturity is increased from 6 percent to 6.6 percent.
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