Definition
Yield to Call (YTC) is the yield on a bond or other fixed-income security that investors would receive if the bond is redeemed by the issuer on the first call date specified in the bond’s indenture agreement. The yield to call calculation assumes that the issuer will exercise its option to call the bond at that date, paying back the face value of the bond and sometimes a call premium. This metric is crucial for investors holding callable bonds, as it provides insight into the potential returns of the bond if called before its maturity date.
Examples
Callable Corporate Bond: A corporate bond with a face value of $1,000, a coupon rate of 5%, and a call feature allows the issuer to redeem the bond in five years. If the bond was purchased at a premium of $1,050 and the issuer decides to call it in five years, the yield to call will incorporate the call price and the remaining interest payments until the call date.
Municipal Bond: A municipal bond issued by a city government with a 4% coupon rate and a call option after ten years. If interest rates decline significantly, the city may call the bond to refinance at lower rates. The YTC helps investors know the yield they will earn if the bond is called at the ten-year mark.
Frequently Asked Questions
Q1: What is the difference between Yield to Call (YTC) and Yield to Maturity (YTM)? Yield to Call assumes the bond will be called at the earliest call date, while Yield to Maturity assumes the bond will be held until its maturity date. YTC considers the call premium and the shorter investment period, unlike YTM which considers the full term of the bond.
Q2: Why is Yield to Call important to investors? Yield to Call is important because it helps investors understand the potential return if the bond is called before maturity, allowing them to make more informed investment decisions, especially in a declining interest rate environment where issuers are likely to call bonds to refinance at lower rates.
Q3: How do call premiums affect the Yield to Call? Call premiums, which are extra amounts paid by the issuer when calling the bond, affect the Yield to Call by increasing the bondholder’s return. Higher call premiums generally result in a higher yield to call.
Q4: Can Yield to Call be lower than Yield to Maturity? Yes, Yield to Call can be lower than Yield to Maturity, especially if the bond is purchased at a premium or if the call date is near. The shorter time horizon for YTC compared to the full term for YTM can lead to a lower yield.
Related Terms
- Callable Bond: A type of bond that allows the issuer to redeem the bond before its maturity date under specified conditions.
- Indenture Agreement: The formal agreement between a bond issuer and bondholders, detailing the terms of the bond, including any call features.
- Coupon Rate: The annual interest rate paid by the bond issuer, typically expressed as a percentage of the face value.
- Call Premium: An added amount paid by the issuer to bondholders when exercising the option to call the bond before its maturity date.
Online Resources
Suggested Books for Further Studies
- “The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau
- “Bond Markets, Analysis and Strategies” by Frank J. Fabozzi
- “Fixed Income Analysis” by CFA Institute
Fundamentals of Yield to Call: Finance Basics Quiz
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