Key Takeaways
- Annualized return if bond called early.
- Reflects call risk on callable bonds.
- Calculated assuming redemption at first call date.
- Helps assess reinvestment risk for investors.
What is Yield to Call?
Yield to Call (YTC) is the annualized return an investor earns by purchasing a callable bond and holding it until the issuer exercises the call option on the specified call date, receiving coupon payments plus the call price. Unlike yield to maturity, YTC assumes the bond is redeemed early, reflecting the impact of the issuer's right to call the bond before maturity.
This measure is essential for investors evaluating bonds with embedded call features, such as callable bonds, where early redemption affects expected returns.
Key Characteristics
Yield to Call provides a realistic return estimate for callable bonds considering the issuer's early redemption option:
- Assumes earliest call date: YTC calculates returns assuming the bond is called at the first possible date, impacting the investment horizon.
- Incorporates call premium: The call price often includes a premium above par value, influencing the yield calculation.
- Reflects call risk: YTC helps you assess reinvestment and call risk inherent in callable bonds compared to standard bonds.
- Differs from yield to maturity: While YTM assumes holding to maturity, YTC focuses on early redemption scenarios.
- Used in bond portfolio analysis: Investors combine YTC with metrics like Macaulay duration to gauge interest rate sensitivity.
How It Works
Yield to Call is calculated by equating the bond’s current market price with the present value of all coupon payments plus the call price, discounted over the years until the call date. This requires solving for the discount rate that sets these cash flows equal to the bond price, typically using financial calculators or spreadsheet functions.
The calculation considers the timing of coupon payments and the call premium, providing an internal rate of return reflecting early redemption risk. If the YTC is lower than the yield to maturity, it signals a higher likelihood of the bond being called, affecting your expected return.
Examples and Use Cases
Understanding Yield to Call helps in evaluating bonds issued by companies prone to refinancing or interest rate changes:
- Airlines: Delta and American Airlines often issue callable bonds, making YTC a key metric for bondholders assessing potential early calls.
- Bond ETFs: Funds like BND include callable bonds, so YTC impacts overall yield calculations and risk assessments.
- Bond selection: When choosing from best bond ETFs, considering YTC helps evaluate the impact of call features on returns.
Important Considerations
When analyzing Yield to Call, keep in mind that it assumes the issuer will call the bond at the earliest date, which may not always happen. Market interest rates, issuer credit quality, and bond price premiums or discounts influence the likelihood of a call.
Investors should use YTC alongside other metrics like yield to maturity and yield to worst to create a comprehensive view of potential returns. Understanding these factors helps you manage call risk effectively within your fixed income portfolio.
Final Words
Yield to Call reveals the true return potential of callable bonds when early redemption is likely, helping you gauge call risk effectively. Compare YTC with Yield to Maturity on your holdings to better understand your investment's risk and reward profile.
Frequently Asked Questions
Yield to Call (YTC) is the annualized return an investor earns by buying a callable bond at its current market price and holding it until the bond is called by the issuer at the earliest call date. It accounts for coupon payments received and the call price paid, which often includes a premium.
Yield to Call assumes the bond is redeemed by the issuer at the first call date, while Yield to Maturity assumes holding the bond until its final maturity date without early redemption. YTC is useful for assessing call risk, especially if the bond is likely to be called early.
Yield to Call helps investors understand the potential return if a bond is called early, which affects reinvestment risk and overall income. It provides a realistic estimate of returns when interest rates decline and issuers refinance at lower costs.
YTC is calculated by finding the discount rate that equates the bond's current price to the present value of all coupon payments plus the call price until the call date. This is typically solved iteratively using financial calculators, Excel functions like RATE, or trial-and-error methods.
Yes, for discount bonds with call premiums, Yield to Call may exceed Yield to Maturity. However, for premium bonds, YTC is often lower because the bond is likely to be called when interest rates drop, limiting the investor's return.
A lower Yield to Call compared to Yield to Maturity typically signals a higher likelihood that the bond will be called early. This implies reinvestment risk for investors, as they may have to reinvest returned principal in a lower interest rate environment.
Yield to Call applies only to callable bonds, which include a predetermined call date and call price allowing issuers to redeem the bond before maturity, often to refinance at lower interest rates.
Yield to Worst is the lowest yield an investor can receive, considering all possible call dates and maturity. It includes Yield to Call scenarios and helps investors plan conservatively by assessing the worst-case return if the bond is called early or held to maturity.
