Chartered Financial Analyst (CFA) Practice Exam Level 2

Yield to Maturity (YTM) is achieved when investors do what with a bond?

1. Hold the bond to maturity and purchase new securities

2. Hold the bond to maturity and reinvest the coupons at YTM

3. Sell the bond before maturity for profit

4. Invest only in short-term bonds

The correct answer is: Hold the bond to maturity and reinvest the coupons at YTM

Yield to Maturity (YTM) represents the total return an investor can expect to earn if they hold a bond until it matures, assuming that all coupon payments are reinvested at the same rate as the YTM. This is important because it factors in not just the interest income from the bond, but also any capital gains or losses that would arise from the bond reaching maturity. Holding the bond to maturity allows the investor to receive the face value of the bond at maturity, and reinvesting the coupons at the YTM ensures that the overall return on the investment aligns with the initially calculated yield. This means that the investor gets the maximum potential return predicted by the YTM calculation, provided that they can indeed reinvest the coupons at that yield rate, which is a key assumption in this context. This understanding clarifies how the other options do not achieve the condition for YTM. Selling the bond before maturity may involve capital gains or losses and typically does not guarantee that the investor achieves the total return of YTM, as the gain from reinvested coupons at YTM is lost. Investing in only short-term bonds or holding the bond while purchasing new securities diverts focus from the specific calculation of YTM connected with holding a single bond