 |
| Image: Moneybestpal.com |
The yield to worst is the lowest yield you may anticipate from a bond, assuming the issuer doesn't go out of business. The worst-case scenario among all potential call dates and bond maturity dates is used to calculate it.
A bond is a type of debt instrument that, until it matures and pays back its principal, periodically pays a fixed amount of interest (face value). Some bonds, however, have provisions that enable the issuer to call (redeem) them before their maturity, typically for a premium over face value. If interest rates decline, the issuer will benefit since they can refinance their debt at a lesser cost.
The investor may also have to reinvest their money at a lesser rate as a result of missing out on future interest payments. As a result, to account for this risk, bonds with call features typically have higher coupons than bonds without them.
By assuming that the issuer will call the bond as soon as feasible, yield to worst accounts for this risk by lowering the investor's yield. For instance, the lowest yield an investor can receive is 4% if a bond has a 10-year maturity and a 5-year call option, the yield to maturity (YTM) is 6% and the yield to call (YTC) is 4%.
Yield to worst is significant because, in contrast to yield to maturity, which implies that the bond will be kept until it matures, it provides a more accurate picture of the prospective return of an investment. Investors can compare bonds with various call characteristics and maturities on an equal footing by using yield to worst.
Since it does not take into account additional variables like credit risk, liquidity risk, inflation risk, or reinvestment risk, yield to worst is not a perfect indicator of risk. As a result, when assessing bonds, investors need also to take other factors like duration, convexity, credit rating, and spread into account.
