The Relationship Between Yield to Maturity and Internal Rate of Return

by Linda Ray, studioD

Yield to maturity is the measurement used to calculate your rate of interest on bonds held until the maturity date. It's often used to calculate the average interest rate you earned at the time the bond matures. The internal rate of return is another term to explain the same amount of profit you can realize when you invest in bonds. The internal rate of return, or rate of interest, is based on a set of projections from the bond issuer based on interest rates, market stability and growth of the organization issuing the bonds.


When any one of the factors that influence the interest you can earn on a bond changes, your rate of return is affected. The internal rate of return is affected on a one-to-one ratio with the yield to maturity, according to Stanford University, making the terms interchangeable. The reality of your interest rate often is more clearly reflected by using the projected rate of return, but also can be used to hide the real adjustments in the promised yield to maturity you actually will receive when you cash it out.


Bond traders use sophisticated calculations to follow the growth or negative return on bonds. It's important that even small nuances are noticed and recorded by the traders, because many bond holders run large pension funds that hold the retirement funds for thousands of employees. Calculations typically are very forward-thinking, as bonds often don't reach maturity for at least 20 years when the yield to maturity or internal rate of return can weather the ups and downs in interest rates.


Holding a bond until it matures gives you a better chance of realizing the proposed internal rate of return. While you'll be able to absorb drastic changes in interest rates over the long term, your yield to maturity also is enhanced by interest that's reinvested in the bonds. Whether you hold your bond until it reaches maturity also relies on the amount of the coupon rate in which you initially invested. A higher coupon rate held to maturity will most likely provide you with a higher internal rate of return.


While the terms are interchangeable because they both reflect the amount of interest you eventually accrue on a bond investment, any given changes in the interest, or yield, are directly proportionate to the ongoing rate of return at any given time. The value of a bond lies in its predicted value in the future. As with most investments, bonds are risky, but you can utilize such calculations as yield to maturity parameters to reduce the risk for investors. Typically, bonds provide a low-risk conservative investment though which you loan money to a government or company in exchange for a certain yield when the bonds mature at a selected future date. The internal rate of return is another term used to reflect the amount of money the company makes with the money you've made available.

About the Author

Linda Ray is an award-winning journalist with more than 20 years reporting experience. She's covered business for newspapers and magazines, including the "Greenville News," "Success Magazine" and "American City Business Journals." Ray holds a journalism degree and teaches writing, career development and an FDIC course called "Money Smart."

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