In today’s business world, we need different methods to find the profit and the loss. Calculating them sometimes might be an easy task, and it can be a complicated process as well. Depending upon the situation, we have two situations we can either use Yield to Maturity, or we can use Discount rate.
Yield to Maturity vs Discount Rate
The main difference between Yield to Maturity and Discount Rate is that Yield to maturity is to give the total value for the bond return. But the discount rate is for finding the interest rates for the loans that are taken by us from the banks. Calculating yield to maturity is a very difficult and complicated process. But calculating the discount rate is not complicated.
Yield to maturity is calculated by investors because of the money they are invested in the company. This will give the return that is earned with the help of a bond. This is a very critical process because the investors will get confused by seeing the amount, and they have to decide which one they are going to add to their portfolio.
The discount rate is used by investors, and we have to pay the money that we borrowed from them at the time of investment. It is not very complicated and requires some simple steps for calculation. The Daily discount rate is also calculated to see where the company stands in the market.
Comparison Table Between Yield to Maturity and Discount Rate
Parameters of Comparison | Yield to Maturity | Discount Rate |
Definition | Used to find the total return of the bond | Used for finding the interest rates taken from the banks |
Advantages | You can compare the present value | It is cheaper so we can easily borrow money from commercial banks |
Disadvantages | The investment maturity will be held up | Sometimes the drop will lead to consequences |
Also known as | Book Yield and Redemption yield | Bank rate |
Formula | It contains a formula and is very complicated to calculate | It does not have any specific formula, and it is very simple to calculate |
What is Yield to Maturity?
Yield to maturity will give the total return on the bond. The bond will be given till it gets matured. This is like a long-term investment, and the bond will also be in the long term. It will be calculated at an annual rate. Calculating this yield to maturity is not an easy task. The process will be very complicated. Only a person with lots of experience in this field can understand all the protocols in the calculating process. The things such as coupons, interests, and the amount you paid will be either reinvested or kept.
That depends on the person and the project they are going to invest in again. If you are interested, you can reinvest them or else you can start with a new one. This yield will be very much similar to the current yield. The current yield is used for determining the annual cash flows. But in the current yield, we do not take the present value for a bond. But in yield to maturity, you will take the present value of a bond. Yield to maturity will be calculated using a formula, and the formula itself is very complicated with square roots.
Once you get all the data that are required for the calculation, you can substitute them in the formula. It will contain two formulas, one with the coupon and the other one with a coupon and a face value. You can use the one you are familiar with. This is an internal rate of return that is earned by an investor. This is important for investors because they are supposed to find the differences and the returns for the company they are invested in.
What is Discount Rate?
The discount rate will refer to the interest rates that are given for the loans taken from the banks. It is also used for calculating the interest rate in which some people use for discounted cash flow. This method is used to analyze the future cash flows with the help of present value. In many banks, a discount rate is a form of money lending policy. It will also help you to identify whether the project that is going to invest in will be good or not.
In that way, you can find whether it is worth investing in this project. This is mostly done with the federal reserve bank. These kinds of loans are almost given by 12 branches of federal banks. These loans won’t take much time to get selected, and they will be done within 24 hours. This rate does not come under the type of market rate. It is the money that we give the investors. This they will expect for the money that they have given.
This method is also used by some companies to calculate the net present value. Calculating the discount rate does not require any complicated formula or steps. It can be done with the help of some simple steps. The only prerequisite required is you should be good at calculating arithmetic operations. You can calculate the daily discount rate as well by visiting the federal bank’s website.
Main Differences Between Yield to Maturity and Discount Rate
- Yield to maturity can help you to find a better future analysis for the company. On the other hand, the discount rate will be cheaper, and you can borrow loans from the banks.
- Calculating the yield to maturity is a very tedious process, and the formula is complicated. On the other hand, the discount rate is simple to calculate and does not require any specific formula.
- Investors calculate the yield to maturity to find the differences and returns for the money they invested. But at the discount rate, we will give the money that we borrowed from the investors.
- The other name used for yield to maturity is book yield and sometimes called redemption yield. On the other hand, the other name used for the discount rate is the bank rate.
- Using yield to maturity might sometimes help your investment maturity. On the other hand, the discount rate might lead to other consequences.
Conclusion
Both these methods are available for calculation in the market. But we should know which ones are convenient depending on the situation we are in. Because sometimes, there might be a higher yield, and in other cases, it will be below. Depending upon that, we can either of the above-mentioned methods. But calculating the yield to maturity is very difficult when we compare it with the discount rate.
Because the formula itself will be very complicated by taking square roots and all, but when we move on to discount rate, it is not complicated, and a person with good arithmetic knowledge in maths can do that calculation.
References
- https://www.jstor.org/stable/2326906
- https://www.researchgate.net/profile/BillYang/publication/263257602_Yield_to_maturity_and_total_rate_of_return_A_theoretical_note/links/56fc083d08aef6d10d91b910/Yield-to-maturity-and-total-rate-of-return-A-theoretical-note.pdf