The Difference Between Yield to Call and Yield to Worst
While the yield on most bonds is measured by their yield to maturity, there are two other measurements for yield: yield to call and yield to worst.
Yield to Call
To understand yield to call, or YTC, it’s necessary to first understand what a callable bond is. A callable bond is a bond that an issuer (usually a corporation or municipality) can redeem – or “call away” – (in other words, pay off) prior to the bond’s maturity date.
Some callable bonds can be called at any time, while others can be redeemed after a fixed period; for instance, a 30-year bond could be callable after ten years has elapsed. Callable bonds typically carry higher yields than non-callable bonds since the bond can be called away from an investor if interest rates fall. The advantage to the issuer is that it has the ability to refinance the bond at a lower rate when rates are dropping.
Yield-to-call is the estimated yield an investor would receive if the bond is called by the issuer prior to its maturity. When a bond is likely to be called away, an investor would want to judge the bond based on its yield to call, rather than its yield to maturity, for the simple reason that it is unlikely to continue trading until its maturity.
The question is, how do you know which yield figure to use?
Yield to Worst
The rule of thumb when evaluating a bond is always to use the lowest possible yield. This figure is known as the “yield to worst”. This leads to the next, question, how do you tell which is lower – yield to maturity, or yield to call?
Here’s the simple rule of thumb:
If a bond is…
… then yield to call is the appropriate figure to use. An example: A bond is maturing in ten years and its yield to maturity is 3.75%. The bond has a call provision that allows the issuer to call the bond away in five years. The yield, when calculated for the bond maturing on the call date, is 3.65%. In this case, 3.65% is the yield-to-worst – and the figure investors should use. Conversely, if the yield to maturity were lower of the two, that would be the yield-to-worst.
Learn more about the features of bonds.
Yield to Call
To understand yield to call, or YTC, it’s necessary to first understand what a callable bond is. A callable bond is a bond that an issuer (usually a corporation or municipality) can redeem – or “call away” – (in other words, pay off) prior to the bond’s maturity date.
Some callable bonds can be called at any time, while others can be redeemed after a fixed period; for instance, a 30-year bond could be callable after ten years has elapsed. Callable bonds typically carry higher yields than non-callable bonds since the bond can be called away from an investor if interest rates fall. The advantage to the issuer is that it has the ability to refinance the bond at a lower rate when rates are dropping.
Yield-to-call is the estimated yield an investor would receive if the bond is called by the issuer prior to its maturity. When a bond is likely to be called away, an investor would want to judge the bond based on its yield to call, rather than its yield to maturity, for the simple reason that it is unlikely to continue trading until its maturity.
The question is, how do you know which yield figure to use?
Yield to Worst
The rule of thumb when evaluating a bond is always to use the lowest possible yield. This figure is known as the “yield to worst”. This leads to the next, question, how do you tell which is lower – yield to maturity, or yield to call?
Here’s the simple rule of thumb:
If a bond is…
- 1) Callable,
- 2) Trading at a premium to its par value (for instance, its price is $105 but its par value is $100), and
- 3) The yield-to-call is lower than the yield to maturity…
… then yield to call is the appropriate figure to use. An example: A bond is maturing in ten years and its yield to maturity is 3.75%. The bond has a call provision that allows the issuer to call the bond away in five years. The yield, when calculated for the bond maturing on the call date, is 3.65%. In this case, 3.65% is the yield-to-worst – and the figure investors should use. Conversely, if the yield to maturity were lower of the two, that would be the yield-to-worst.
Learn more about the features of bonds.