What Is Yield to Worst (YTW)?
Let me explain yield to worst directly: it's a measure of the lowest possible yield you can receive on a bond that fully operates within the terms of its contract. You reference this type of yield when a bond has provisions allowing the issuer to close it out before maturity. As an investor, YTW helps you manage risks and ensure your specific income requirements are still met, even in the worst scenarios.
Key Takeaways
- Yield to worst is a measure of the lowest possible yield that can be received on a bond with an early retirement provision.
- It assumes the bond is paid off at the earliest date allowed by its terms, such as through a call or early redemption.
- Yield to worst is often the same as yield to call.
- Yield to worst must always be less than yield to maturity because it represents a return for a shortened investment period.
Understanding Yield to Worst (YTW)
You calculate a bond's YTW based on the earliest call or retirement date. Assume that a prepayment of principal occurs if the bond issuer uses the call option. After the call, the principal is usually returned, and coupon payments stop. An issuer will likely exercise their callable option if yields are falling and they can obtain a lower coupon rate through new issuance in the current market environment.
YTW may also be known as the yield to call (YTC). To identify the YTW, you should calculate both yield to call and yield to maturity. In general, YTW may be the same as yield to maturity, but it can never be higher since it represents yield for you at an earlier prepayment date than the full maturity. YTW is the lowest possible return you can achieve from holding a particular bond that fully operates within its contract without defaulting. Note that YTW is not associated with defaults, which are different scenarios altogether.
The opposite of yield to worst is yield to best, which represents the highest possible yield you could receive from a bond.
The Mechanics
The yield to call is an annual rate of return, assuming a bond is redeemed by the issuer at the earliest allowable callable date. A bond is callable if the issuer has the right to redeem it prior to the maturity date. YTW is the lower of the yield to call or yield to maturity. A put provision gives you the right to sell the bond back to the company at a certain price at a specified date. There is a yield to put, but this doesn't factor into the YTW because it's your option on whether to sell the bond. As a bond investor, you will also review similar-duration securities' spread-to-worst (STW) values. STW calculates the difference between the YTW of a bond and a U.S. Treasury security.
The equation for calculating YTC is: YTC = (coupon interest payment + (call price - market value) ÷ number of years until call) ÷ ((call price + market value) ÷ 2).
Analyzing Yields
Yields are typically always reported in annual terms. If a bond is not callable, the yield to maturity is the most important and appropriate yield for you to use because there is no yield to call.
If a bond is callable, it becomes important for you to look at the YTW. The yield to maturity will always be higher than the YTW because you earn more when you hold the bond for its full maturity. YTW is important though because it provides deeper due diligence on a bond with a call provision. The shorter time frame a bond is held for, the less you earn. YTW provides a clear calculation of this potential scenario showing the lowest yield possible.
Some other types of yield that you might also want to consider include running yield and nominal yield.
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