Key Takeaways
- Lowest yield assuming no default on callable bonds.
- Minimum of yield to maturity and yields to call.
- Shows worst-case return if issuer redeems early.
- Equals yield to maturity for non-callable bonds.
What is Yield to Worst (YTW)?
Yield to Worst (YTW) represents the lowest possible yield an investor can receive from a callable bond without the issuer defaulting. It is calculated as the minimum between the yield to maturity and all potential yields to call.
This metric provides a conservative estimate of returns, particularly useful when issuers have the option to redeem bonds early, typically to refinance at a lower cost.
Key Characteristics
YTW is essential for understanding downside risk in callable bonds. Key features include:
- Conservative Yield Estimate: YTW offers the lowest expected yield assuming no default, helping you assess potential yield reductions due to early calls.
- Callable Bonds Focus: Primarily relevant for bonds with call provisions; for non-callable bonds, YTW equals yield to maturity.
- Includes Multiple Call Dates: Considers all possible call dates and yields, taking the minimum to represent the worst case.
- Depends on Face Value: Calculation requires knowledge of the bond’s face value and call prices.
- Risk Metric for Income Investors: Useful for those relying on steady income, as it signals the lowest yield they might realistically receive.
How It Works
Calculating YTW involves determining the yield to maturity and each potential yield to call, then selecting the smallest. Since callable bonds can be redeemed early, YTW reflects the risk that the issuer exercises this option, limiting your return.
For example, if a bond is trading at a premium, the issuer might call it when interest rates fall, meaning your actual yield could be closer to the yield to call than the yield to maturity. Tools like Excel’s IRR function can help you compute these yields precisely.
Examples and Use Cases
Understanding YTW is particularly useful for investors evaluating bonds issued by companies or funds that frequently issue callable debt.
- Airlines: Delta and other carriers may issue callable bonds, where YTW helps assess the minimum return given the issuer’s option to refinance.
- Bond ETFs: When selecting funds like BND, knowing the YTW of underlying callable bonds aids in estimating worst-case income scenarios.
- Municipal Bonds: YTW is widely applied in municipal bonds, and you can compare yields with guides such as best bond ETFs to balance risk and reward.
Important Considerations
While YTW provides a conservative yield floor, it excludes default risk, so it shouldn’t be your sole measure of safety. The metric assumes the issuer will act rationally by calling bonds when beneficial, which may not always occur promptly.
Additionally, YTW calculations can be sensitive to interest rate fluctuations and multiple call dates, so staying informed about changes in market conditions and issuer credit profiles is critical for managing your fixed-income portfolio effectively.
Final Words
Yield to Worst provides a conservative estimate of your bond’s potential return, especially for callable bonds. To make informed decisions, calculate YTW alongside other yields to identify the least favorable scenario before committing your capital.
Frequently Asked Questions
Yield to Worst (YTW) is the lowest potential yield an investor can receive on a callable bond, assuming the issuer doesn’t default. It’s calculated as the minimum of the yield to maturity and all possible yields to call, representing a conservative estimate of return.
Yield to Maturity (YTM) assumes the bond is held until maturity, while Yield to Call (YTC) assumes the bond is called early at a specified date. Yield to Worst (YTW) takes the lowest yield among YTM and all YTCs, offering a conservative measure for callable bonds.
YTW helps investors understand the worst-case yield they might receive if the issuer calls the bond early, which often happens when interest rates drop. This helps assess downside risk and compare bonds with embedded call options.
YTW equals YTM for non-callable bonds or for callable bonds trading at or below par because calling the bond early would be unattractive to the issuer, so the bond is likely held to maturity.
YTW is calculated by first finding the Yield to Maturity and the Yield to Call for each call date, then taking the lowest yield among them. This typically requires using financial calculators or Excel’s IRR function for accuracy.
For a premium callable bond trading above par, the YTW is often the lowest Yield to Call because the issuer is likely to call the bond early. For example, if YTM is 3.8% but the bond can be called in 5 years at an effective yield of 4.0%, the YTW would be 4.0%.
No, Yield to Worst assumes the issuer does not default. It reflects the worst potential yield accounting for early calls but excludes credit risk or default scenarios.
In Excel, you can use the IRR function on the bond’s cash flows for maturity and each call date scenario. After calculating all yields, the Yield to Worst is the minimum of these IRRs.
