Day 92 : Yield to Maturity
There is no way of knowing your returns if you hold a share for five years in equity investments. This is not the case with debt.
If you buy a bond or fixed maturity plan debt fund and hold it till maturity, you will get a fixed percentage return. This is called yield to maturity (YTM).
To better understand this, assume you buy a bond for ₹900, which will give you a sum of ₹1,000 after 2 years, on maturity. The YTM of this bond is 5.41%.
The bond might even pay interest (or coupon) in many cases. Here, the calculation of YTM will not be the same.
Long-term bonds and debt funds that trade for a duration greater than five years may be subject to a lot of change if you don't plan on holding them till maturity. This happens because of the price of the underlying bonds changes.
Bonds prices can decline if the interest rate in the economy rises. Why does this happen?
The effective yield also has to increase to match the rising interest rates for new buyers. Hence, a ₹100 bond might sell at ₹99 to raise its YTM.
Similarly, bond prices will also increase if the interest rates decline.
We measure the sensitivity of a bond to changes in interest rates using a parameter called duration.
In technical terms, it is a measure of interest rate risk. Bonds with long maturities or low coupon have higher interest rate risks.
Since different bonds have different durations, they will not rise or fall at the same rate.
If you expect interest rates to fall, choosing bonds with a higher duration is wise since they will show a more significant increase.
If one expects rates to increase, buying a bond with less duration makes more sense.
If you go for a higher duration in search of returns, interest rate movement can take away most of your returns.
In conclusion, always look for a higher YTM bond or debt fund, given that all other factors remain the same.
92/100
#100daysofpersonalfinance