Yield to Call (YTC) is an essential financial metric that describes the yield of a bond or note if it is held until the earliest possible call date, rather than to maturity. This measure helps investors evaluate the return on investment considering the possibility of the issuer calling back the bond before its maturity.
How to Calculate Yield to Call
The calculation of Yield to Call involves several variables, including call price, current bond price, coupon payments, and the time remaining until the call date. The YTC can be calculated using the following formula:
Where:
- \( C \) = Annual coupon payment
- \( Call Price \) = Price at which the bond can be called
- \( Current Price \) = Current market price of the bond
- \( N \) = Number of years until the call date
Example Calculation
Consider a bond with:
- A $1,000 call price
- 5% annual coupon rate
- Current price of $950
- 3 years until the call date
The annual coupon payment is $50. Plugging these figures into the YTC formula gives an approximation of the yield:
Why Yield to Call Matters
Assessing Risk and Return
Yield to Call provides a more accurate picture of potential returns when bonds can be called before maturity. It reflects the fact that callable bonds come with inherent interest rate risk; issuers are likely to call bonds when interest rates decline, forcing investors to reinvest at lower yields.
Comparison with Yield to Maturity
While Yield to Maturity (YTM) assumes the bond will be held to maturity, YTC considers the earliest call date. This distinction is crucial for callable bonds, where the call date may be earlier than the maturity date, affecting the yield.
Investment Decisions
Investors use YTC to determine whether a bond’s yield is attractive taking into account the likelihood of it being called. A higher YTC relative to YTM can indicate that a bond is less likely to be called, adding another layer to investment strategy decisions.
Historical Context
The concept of callable bonds and their respective yields has been a staple in bond markets for decades. Since World War II, governments and corporations have used callable bonds to take advantage of declining interest rates, issuing new bonds at lower rates and calling older, higher-rate bonds.
Related Terms
- Yield to Maturity (YTM): The total return anticipated on a bond if it is held until it matures, considering all coupon payments and the difference between the purchase price and the maturity value.
- Current Yield: A measure of the income (interest or dividends) provided by a bond or other investment relative to its current price.
- Call Date: The specific date on which a bond can be redeemed by the issuer before its maturity date.
- Callable Bonds: Bonds that can be redeemed by the issuer prior to the maturity date at a predetermined call price.
FAQs
What factors influence Yield to Call?
How does YTC differ from Yield to Maturity?
Why do issuers call bonds?
Summary
Yield to Call is a critical metric for investors in callable bonds, providing a forecast of potential returns based on the assumption that the bond is called at the earliest date. By understanding and calculating YTC, investors can better assess the attractiveness and risk of callable bonds in their portfolios.
References
- “Investing in Bonds: A Comprehensive Guide,” Financial Times Press.
- Bodie, Z., Kane, A., & Marcus, A. J. (2021). Investments. McGraw-Hill Education.
- CFA Institute. (2023). CFA Program Curriculum.
