Remember, that when you increase the time to maturity the principal repayment will happen after a longer time frame. That will affect your current price. Let us look at the base case scenario first.

Bond Yield Example Data

Face Value

? 1,000

Annual Coupon Rate

8.00%

Annual Required Return

8.50%

Years to Maturity

5.0

Years to Call

2.0

Call Premium %

5.00%

Payment Frequency

4

Value of Bond

? 979.81

Bond Yield Calculations

Current Yield

8.16%

Yield to Maturity

8.50%

Yield to Call

11.40%

In the above base case scenario, the coupon rate is at 8% and the market yield is at 8.5%. The YTM is obviously higher than the current yield because the coupon rate is lower at just 8%. Now what happens when the term to maturity is increased to 10 years instead of 5 years? What will be the impact on YTM and current yields? Check the table below?

Bond Yield Example Data

Face Value

? 1,000

Annual Coupon Rate

8.00%

Annual Required Return

8.50%

Years to Maturity

10.0

Years to Call

2.0

Call Premium %

5.00%

Payment Frequency

4

Value of Bond

? 966.54

Bond Yield Calculations

Current Yield

8.28%

Yield to Maturity

8.50%

Yield to Call

12.16%

You are going to find the answer quite surprising. The tenure has gone up from 5 years to 10 years. While the current yield has gone up from 8.16% to 8.28%, the YTM is the same in both the cases. Why is that so?

YTM is an internal rate of return. It is immaterial whether it is a 10 year bond or a 5 year bond as long as the coupon and YTM don’t change. But why does current yield change. When the tenure is extended, the biggest principal component becomes more distant and that reduces the present value of the bond. This results in lower price of the bond (which is the present value of future cash flows anyways. Since the price goes down, being the denominator, the current yield goes up. That is the way it works.