Common Myths on Yield to Maturity in Bonds or IRR in Corporate Finance

Serie Documentos de Trabajo, Nro. 764

13 Pages Posted: 22 Mar 2021

Date Written: November 2020

Abstract

The yield to maturity (YTM) or internal rate of return (IRR) is a metric used in financial analysis to estimate the profitability of potential investments. Almost all finance textbooks state the following conditioning assumptions:(i) that the coupon payments can be reinvested at a rate equal to the yield to maturity,(ii) that the bond is held to maturity We show that there are two common fallacies about these assumptions, and none of them are necessary to interpret this return measure, and they may have probably arisen as a consequence of a semantic misunderstanding. The calculation of the YTM/IRR is the result of an ex ante mathematical operation focusing on current and future cash flows, regardless of the reinvestment rate, which is different from wealth accumulation. At the end of the paper we provide some numerical examples.

Keywords: Yield to maturity, Project evaluation, Internal rate of return, Cash flows

JEL Classification: G31, G12, G11

Suggested Citation

Dapena, José Pablo and Schefer, Ricardo, Common Myths on Yield to Maturity in Bonds or IRR in Corporate Finance (November 2020). Serie Documentos de Trabajo, Nro. 764, Available at SSRN: https://ssrn.com/abstract=3805719 or http://dx.doi.org/10.2139/ssrn.3805719

José Pablo Dapena (Contact Author)

University of CEMA ( email )

1054 Buenos Aires
Argentina

Ricardo Schefer

Universidad del CEMA ( email )

Av Cordoba 374
Buenos Aires, C1054AAP
Argentina
+54 11 6314 3000 (Phone)
+54 11 4314 1654 (Fax)

HOME PAGE: http://www.cema.edu.ar/u/ras

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