Sorry if this is an old question but I cannot find the answer.How does APR differ from YTM?So to help me understand if I wanted to compare a money market account earning 5% APR how would that compare if I left $10,000 in that account for 5 years as compared to purchasing a five year non-callable bond at 5% YTM?I know it is confusing because the bond is paying out every six months so lets say that the repayment money is put in a 5% MM.How much money would I have left in each at the end of 5 years?Thank you for your help in understanding this concept (yes, I understand there are no MM accounts earning 5%).
grold,You wrote, How does APR differ from YTM?See YTM: http://www.investopedia.com/terms/y/yieldtomaturity.aspQuoting, The YTM calculation takes into account the bond’s current market price, par value, coupon interest rate and time to maturity. It is also assumed that all coupon payments are reinvested at the same rate as the bond’s current yield.Both APR and YTM are compound (annualized) interest rates that assume reinvestment. However, YTM takes into account the fact that the current price and the redemption price (at maturity) of a bond may be different. YTM assumes maturity is the maturity date of the bond. APR usually describes the rate paid on the balance of a loan. This can be different from the coupon rate as well, since APR expresses a compound (reinvested) annualized interest rate based on the balance of the loan and the coupon rate is simple interest. However note that the APR and the coupon rate will typically be very close when rates are low. In general APR is not a useful metric for bond investors. YTM always is.There is another term, YTW - Yield to Worst. http://www.investopedia.com/terms/y/yieldtoworst.aspThis is one of the number you need to know when the bond (or preferred) you are researching is callable. Yield to worst describes the effective rate you would receive if the bond is called at the earliest possible opportunity. Quoting Investopia, The lowest potential yield that can be received on a bond without the issuer actually defaulting. The yield to worst is calculated by making worst-case scenario assumptions on the issue by calculating the returns that would be received if provisions, including prepayment, call or sinking fund, are used by the issuer. This metric is used to evaluate the worst-case scenario for yield to help investors manage risks and ensure that specific income requirements will still be met even in the worst scenarios.- Joel
Lets say you have a $2000. You put $1000 in a one year bond earning 1% YTM...any payments go into a safe.You put the other $1000 into a 1% APY Money Market and any interest payments go into another safe.At the end of one year you take back your $2000. Which safe has more money in it?
You have to factor in the value of the bond in this scenario. You are not necessarily going to get 1% income on a bond that has a 1% YTM.That YTM factors in the value of the bond so the current yield (the interest you get on the bond) could be higher or lower than 1% due to the current value.For example (and just pulling numbers from the air), you could have a bond paying a 2% coupon ($20 on a $1000 face value bond), that has a YTM of only 1% because the current price is $1100 with a maturity date of 2020 (again, numbers made up). The value of the bond will go down to the $1000 face value as it approaches 2020. The opposite could also be true. The bond could have a coupon of .5% yet the YTM is 1% due to the current price/value being below the face value.If you want a bond that pays 1%, you need to buy one that has a current yield of 1%, not a YTM of 1%.
And then comes compounding if the bond is held for other than 12 mo.
Here is what I think the answer is to my question....The money market account will have $10 in the safe if it is compounded yearly or $10 and 5c if compounded daily based on this calculator...https://www.bankofinternet.com/calculators/apy-interest-calc... The safe with the bond (based on a par purchase of the bond and a coupon rate of 1%) will have $10 in it if the coupons are paid annually. THERE IS SOMETHING I AM DOING WRONG WITH THE CALCULATOR ON THIS PAGEOr keeping the YTM at 1% and there are 2 semi-annual payments and the coupon is 2%http://www.investopedia.com/calculator/aoytm.aspx...then there will be how much in the second safe? $20from that site..."A bond that pays 2 coupon(s) of 2.00% per year, that has a market value of $1,000.00, and that matures in 1 years will have a yield to maturity of 1.00%."http://www.investinganswers.com/calculators/yield/yield-matu...According to this calculator, the YTM is 1% to make a YTM of 1% in one year with 2 payments (purchased and sold at $1000)Why does one calculator say the coupon should be 2% and the other says 1% to get a YTM of 1% with 2 payments on a par purchase of one bond for one year.Thanks for your help...just trying to get this idea through my brain. Kevin.
grold,You wrote, The money market account will have $10 in the safe if it is compounded yearly or $10 and 5c if compounded daily based on this calculator...Your statement is unclear to me. Let me restate it, If I place $10 in a money market paying 1% APY, compounded yearly, I will have $10.10 at the end of the year. If I change the compounding to daily, I will have $10.10 at the end of the year.If you change the compounding rate, the amount owned at the end of the year will never change so long as the APY is unchanged. That is the point of APY - it states what interest you will receive, as a percentage of your principal investment, after one year's time - assuming the principal investment remains constant and interest payments are reinvested at the same rate.Now if you were talking APR, that would change from 1.00% to something like 0.99% for the same scenario. That's because it is talking about what you receive for a given interest payment without compounding. APR is the coupon rate. The coupon is the total amount of interest you will receive expressed as a percentage of the principal investment after one year, assuming the interest payments are NOT reinvested.Also, THERE IS SOMETHING I AM DOING WRONG WITH THE CALCULATOR ON THIS PAGEOr keeping the YTM at 1% and there are 2 semi-annual payments and the coupon is 2%http://www.investopedia.com/calculator/aoytm.aspx...then there will be how much in the second safe? $20from that site..."A bond that pays 2 coupon(s) of 2.00% per year, that has a market value of $1,000.00, and that matures in 1 years will have a yield to maturity of 1.00%."The investopia calculator is wrong. It is treating the "Maturity in Years" field as the "number of periods" part of the calculation. To calculate it correctly, it should be multiplying that number by 1, 2 or 4 depending on the selected payment frequency ... but it is not.So please ignore this calculator - its wrong.- Joel
In the real world, there is no way to know how much will be earned in the money market account after 5 years. The very nature of a money market is that rates change pretty often (the recent long period of near-zero interest rates is an anomaly) and thus the amount earned each period will vary. Sometimes it can vary rather dramatically.
MarkR,You wrote, In the real world, there is no way to know how much will be earned in the money market account after 5 years.Truth!In the real world, there is no way to know how much will be earned in a money market account after 5 days!- Joel
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