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Yield to call measures the return on investment for a bondholder who keeps a callable bond until the call date, which comes before the maturity date.Â
Bonds that are callable are those that can be redeemed early by the investor or the issuer at a call price. Mathematical formulas or computer algorithms can be used to calculate yield to call. Yield to call displays the minimum return an investor would get if the bond were called as soon as possible.
Because they carry a higher level of risk for the investor, callable bonds often have a higher yield to maturity than non-callable bonds. When interest rates decline, the issuer has the option to call the bond and refinance its debt at a cheaper rate. The investor will therefore miss out on future interest payments and might have to reinvest the principal at a lesser rate. In order to offset this risk, the investor requests a greater yield.
Nevertheless, because it assumes that the bond will be kept to maturity, which may not happen, yield to maturity is not a reliable indicator of return for callable bonds. Since yield to call accounts for the potential for early redemption, it provides a more accurate return projection. Investors can evaluate various callable bonds with various call dates and prices using yield to call.
YTC = (C / 2) x { (1 - (1 + YTC / 2) ^ -2t) / (YTC / 2)} + (CP / (1 + YTC / 2) ^ 2t)
Where:
Using a computer program or an online calculator, you can find that the yield to call is 7.43%.
This indicates that you will receive an annualized return of 7.43% if you purchase the bond at $1,100 and stick to it until it matures at $1,050 after 5 years.
Because they carry a higher level of risk for the investor, callable bonds often have a higher yield to maturity than non-callable bonds. When interest rates decline, the issuer has the option to call the bond and refinance its debt at a cheaper rate. The investor will therefore miss out on future interest payments and might have to reinvest the principal at a lesser rate. In order to offset this risk, the investor requests a greater yield.
Nevertheless, because it assumes that the bond will be kept to maturity, which may not happen, yield to maturity is not a reliable indicator of return for callable bonds. Since yield to call accounts for the potential for early redemption, it provides a more accurate return projection. Investors can evaluate various callable bonds with various call dates and prices using yield to call.
How to Calculate Yield to Call?
The formula for yield to call is:YTC = (C / 2) x { (1 - (1 + YTC / 2) ^ -2t) / (YTC / 2)} + (CP / (1 + YTC / 2) ^ 2t)
Where:
- YTC = yield to call
- C = annual coupon payment
- CP = call price
- t = number of years until the call date
The yield to call must be determined using an iterative approach or a computer program since this formula cannot be solved directly.
As an illustration, let's say you decide to purchase a callable bond with a $1,000 face value, a 10% coupon rate, and a 10-year maturity date. The bond is callable after five years for $1,050. The bond currently has a $1,100 market value.
Using a computer program or an online calculator, you can find that the yield to call is 7.43%.
This indicates that you will receive an annualized return of 7.43% if you purchase the bond at $1,100 and stick to it until it matures at $1,050 after 5 years.
Advantages of Yield to Call
Yield to call has some advantages for investors and issuers of callable bonds.- For investors, yield to call helps them evaluate the potential return and risk of callable bonds. It also helps them compare different callable bonds with different features and prices.
- For issuers, yield to call helps them decide when to call their bonds and refinance their debt. It also helps them price their callable bonds according to market conditions and investor expectations.
