What Is Yield To Call?
Let me explain yield to call (YTC) directly: it's the return you'll get as a bondholder if you hold the bond until its call date, which happens before the full maturity.
This applies to callable bonds, where either you as the investor can redeem it or the issuer can repurchase it on that call date at the call price. By definition, the call date comes before maturity.
You can calculate this mathematically as the compound interest rate where the present value of the bond's future coupon payments plus the call price equals the current market price.
Bonds are typically callable over several years, often at a slight premium above face value, but the exact price depends on market rates at the time.
Key Takeaways
- Yield to call is for callable bonds, allowing redemption by investors or repurchase by issuers before maturity.
- You can calculate YTC using computer programs through an iterative process.
- Issuers might call bonds if interest rates drop, replacing them with cheaper financing.
- Investors call bonds to cash in and reinvest or use the principal.
Understanding Yield To Call
Many bonds are callable, like those from municipalities or corporations. If rates fall, the issuer might pay off the debt and refinance cheaper.
When you calculate YTC, it shows your return assuming the bond is called earliest possible, bought at current price, and held to that date.
Importantly, YTC is often seen as a better estimate of your expected return than yield to maturity.
Calculating Yield To Call
The formula for YTC is straightforward, though solving it requires iteration.
Here's the full formula: P = (C / 2) x {(1 - (1 + YTC / 2) ^ -2t) / (YTC / 2)} + (CP / (1 + YTC / 2) ^ 2t), where P is current price, C is annual coupon, CP is call price, t is years to call, and YTC is what you're solving for.
You can't solve YTC directly; use iteration by hand or software to find it quickly.
Yield To Call Example
Take a callable bond with $1,000 face value, 10% semiannual coupon, priced at $1,175, callable at $1,100 in five years. Maturity years don't factor in.
Plugging into the formula: $1,175 = ($100 / 2) x {(1- (1 + YTC / 2) ^ -10) / (YTC / 2)} + ($1,100 / (1 + YTC / 2) ^ 10).
Iteration shows YTC at 7.43%.
Are Callable Bonds Better than Non-Callable Bonds?
Some investors prefer non-callable bonds because the issuer is stuck with the rate until maturity. That's why non-callable ones pay slightly less interest—the issuer bears the rate change risk.
Are Most Bonds Callable?
Yes, most corporate and municipal bonds are callable, but U.S. Treasury bonds and notes usually aren't.
What Happens to Callable Bonds When Interest Rates Rise?
When rates rise, issuers are less likely to call the bond since replacing it wouldn't save money. But if rates drop, they're more likely to call and refinance.
The Bottom Line
If you're investing in callable bonds, know the yield to maturity, but focus more on yield to call—it's what you'll get if the issuer calls early.
For certainty on your expected yield to maturity, go for non-callable bonds. They pay less but guarantee the income stream.
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