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Bond Yield

Factors That Influence Bond Yield

The yield to maturity (YTM) is compensation to bond investors for assuming the sources of risk inherent in the bond. This compensation is for:

1. Pure “time value of money,” that is, for tying up your money in a risk-free investment; denote this compensation by “RF.”
2. Uncertain future inflation; call the associated compensation “IP.”
3. Liquidity of the asset; the longer you need to wait to sell an asset, the lower the liquidity, and thus, the higher the compensation; call it “LP”
4. The longer the maturity of the bond, the higher the compensation; call it “MP”.
5. The possibility of not getting paid, i.e., default risk. Call it “DP.” Combing these components we have,
   
   • YTM = RF + IP + LP + MP + DP (*)

   In the case of U.S. Treasury bonds, the DP and LP are assumed to be zero.

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