Redemption Yield

Background

Redemption yield, also known as yield to maturity (YTM), is a crucial concept in finance and investment. It represents the annualized return an investor can expect to earn if they hold a fixed-income security, such as a bond, until its maturity date. This yield includes the interest payments received and the difference between the purchase price and the face/redeemable value of the bond.

Historical Context

The concept of redemption yield has evolved alongside the financial markets, with its roots tracing back to the creation of sovereign bonds and the establishment of central banking systems. Throughout financial history, lend and borrow practices have necessitated a reliable method to calculate expected returns, especially when comparing bonds of differing maturities and coupon rates. Redemption yield gradually became a standardized metric around the 20th century as bond markets matured globally.

Definitions and Concepts

Redemption yield refers to the interest rate that equates the present value of all expected future interest payments and the repayment of principal with the bond’s market price. The calculation assumes that interim payments are reinvested at the same rate as the yield to maturity and that the bond will be held until it matures.

Major Analytical Frameworks

Classical Economics

Classical economics doesn’t delve deeply into bond-specific finance theories but contributes by promoting the understanding of overall financial markets, the role of investment, and interest.

Neoclassical Economics

Neoclassical frameworks often focus on equilibrium conditions, offering insight on how interest rates (including redemption yields) come to clear bond markets, balancing supply and demand for securities.

Keynesian Economics

Keynesian models assess the impact of economic policy on interest rates and yields, suggesting that government interventions and fiscal policies heavily influence bond prices and yields especially in varied economic cycles.

Marxian Economics

Marxian economics might examine redemption yields in light of capital accumulation and the role of financial instruments in supporting capitalist systems, though it typically pays more attention to broader class struggles and inequalities.

Institutional Economics

Institutional economics involves evaluating how institutional factors like regulatory environments, financial innovations, and historical contexts shape bond market dynamics and, therefore, observed yields.

Behavioral Economics

Behavioral studies might detail how investor biases and psychological factors impact bond pricing, yield determination, and how individuals interpret and act on yields like redemption yield.

Post-Keynesian Economics

Post-Keynesian perspectives reconcile yield notions with ideas of financial instability and speculative dynamics, examining how redemption yield might reflect broader uncertainties and fluctuation expectations.

Austrian Economics

Austrian insights may view redemption yield through the lens of time preference and subjective value, and how individuals ascertain intertemporal choices regarding investment underuncertainty and market conditions.

Development Economics

Redemption yield in development economics can figure in discussions about government bonds in developing markets, affected by unique risks and economic structures endemic to those regions.

Monetarism

Monetarist perspectives might link the concept of redemption yield directly with inflation expectations and central bank monetary policy, emphasizing the relationship between money supply management and bond yields.

Comparative Analysis

Redemption yield is often compared with current yield, which solely measures annual coupon payments against the bond’s price, and with nominal interest rates, which do not account for capital gains or adjustments for present value computations.

Case Studies

Analysis often includes practical case studies about government bond issues and corporate bond yield variations, comparing pre- and post-crisis periods, assessing yield spreads in variably-rated bonds, and other context-specific evaluation of bond markets.

Suggested Books for Further Studies

“Fixed Income Analysis” by Barbara S. Petitt and Jerald E. Pinto
“Investments” by Zvi Bodie, Alex Kane, and Alan Marcus
“The Handbook of Fixed Income Securities” by Frank J. Fabozzi

Current Yield: This is the bond’s annual coupon payment divided by its current market price.
Yield to Call (YTC): Similar to redemption yield, but assuming the bond will be called (repurchased by the issuer) before its maturity date.
Bond Duration: A measure of the sensitivity of the price of a fixed-income investment to changes in interest rates, expressed in years.
Discount Rate: The interest rate used in discounting future cash flows to their present value.