The single discount rate which, when applied to all cash flows including principal repayment, give a bond price equal to its market price. Let’s build on the example given in “tutorial: bond pricing“. The market price must be equated with the sum of all the cash flows attainable over the bond’s life:
Suppose the bond’s market price is $98.5. If y denotes the yield, then:
2.5. e – y*0.5 + 2.5. e – y*1.0 + 2.5. e – y*1.5 + 102.5. e – y*2.0 = 98.5
By solving for y, we find: y= 5.72%
For more details on calculations, download Excel sheet: calculating bond yield.
