In investing, not all bonds are created equal. Some offer more favorable returns than others based on metrics like interest rates, time to maturity, and call provisions.
Yield to call (YTC) is a crucial calculation for determining the expected return on callable bonds – those that can be redeemed by the issuer before maturity.
While yield to call may seem complex at first glance, it’s easy to understand and calculate with the right knowledge
In this comprehensive guide, we’ll walk through what yield to call is, why it matters, and the step-by-step process for accurately calculating it in your accounting and investing. Let’s get started!
What is Yield to Call?
Yield to call calculates the total expected return from holding a callable bond until the first call date when it may be redeemed by the issuer.
The yield to call metric helps investors evaluate whether the potential income from a callable bond is worth accepting reduced interest payments in the future if it is called early.
For example say a company issues a 5-year semiannual coupon bond at 8% interest that is callable after 3 years. An investor considering this bond wants to know their total yield if it is called at the 3 year mark. This is where yield to call comes in.
Now let’s look at how to calculate YTC step-by-step.
How to Calculate Yield to Call (YTC) in 5 Steps
Here is the formula and process for accurately determining yield to call
Step 1. Identify the Call Price
The call price is the amount the bond will be redeemed for at the first call date. For example, a bond may be called at 104, meaning the issuer will pay back 104% of par value when they redeem it early.
Step 2. Identify the Par Value
Par value (also called face value) is the amount the bond was issued at – typically $100 or $1,000.
Step 3. Identify the Coupon Rate
The coupon rate is the annual interest rate paid by the bond, expressed as a percentage of par value. For example, a 5% coupon bond pays $50 annually per $1,000 of par value.
Step 4. Calculate the Total Interest Earned
To get total interest, multiply the coupon rate by par value. For example, a 5% coupon on a $1,000 par value bond pays $50 in annual interest.
Step 5. Plug it All into the Yield to Call Formula:
YTC = (Interest Earned + Call Price – Par Value) / (Call Price x Number of Years to Call)
Let’s walk through an example:
- Par Value = $1,000
- Coupon Rate = 5%
- Annual Interest = 0.05 x $1,000 = $50
- Call Price = $1,020 after 3 years
- YTC = ($50 + $1,020 – $1,000) / ($1,020 x 3) = 5.06%
And there you have it! The yield to call is 5.06% based on the first call price. This gives the investor the true expected yield on the bond.
Why is Calculating Yield to Call Important?
There are two main reasons yield to call matters for investors and analysts:
1. It provides the true yield expected on a callable bond if called before maturity.
Since many bonds are callable, YTC gives a more accurate expected return than just looking at the coupon rate.
2. It allows for comparing callable bonds of different durations and call dates.
Yield to call normalizes total yield expectations on bonds to help identify which offers the best income potential.
Without accurately determining YTC, investors might overpay for bonds that will be called early and underpay for ones with higher yields to call.
Tips for Calculating Yield to Call
Follow these tips for seamlessly incorporating yield to call calculations into your bond analysis:
-
For bonds with multiple call dates, calculate YTC at each point and use the lowest value for a conservative estimate.
-
Use YTC calculators to avoid formulas and quickly compare YTC across bonds.
-
Understand when YTC or yield to maturity (YTM) is the more relevant metric depending on call likelihood.
-
Update YTC estimates as interest rate forecasts change the probability of the bond being called.
-
For zero-coupon bonds, use yield to put instead, calculating expected yield if sold before maturity.
Mastering yield to call unlocks better investment decision making.
Demystify This Powerful Metric
At first glance, yield to call may seem confusing. But as we’ve shown, it’s easy to understand and calculate with the right grasp of the key inputs.
Now you have the knowledge to expertly determine yield to call on any callable bond and make smart investing choices based on true expected yields.
So the next time you analyze a new callable bond investment, confidently calculate YTC. Having mastery of this metric provides an advantage in accurately comparing bonds and making profitable decisions.
Armed with this guide, you can stop being intimidated by yield to call calculations and start leveraging them to boost returns!
What Is Yield To Call?
Yield to call (YTC) is the return that a bondholder will be paid if the bond is held until the call date, which will occur sometime before the bond reaches maturity.
Yield to call applies to callable bonds, a type of bond that allows the investor to redeem the bond or the bond issuer to repurchase it on the call date, at a price known as the call price. By definition, the call date of a bond occurs before the maturity date.
This number can be mathematically calculated as the compound interest rate at which the present value of a bonds future coupon payments and call price is equal to the current market price of the bond.
Generally speaking, bonds are callable over several years. They are normally called at a slight premium above their face value, though the exact call price is based on prevailing market rates.
- Yield to call applies to callable bonds, which are securities that allow the investors to redeem the bonds or the bond issuer to repurchase them before the bonds reach maturity.
- Yield to call can be mathematically calculated, using computer programs.
- A bond issuer might call a bond if interest rates change, making it more cost-effective to replace the bond with a new issue that has more favorable terms.
- An investor would call a bond to cash it in and reinvest or use the principal.
Yield To Call Example
As an example, consider a callable bond that has a face value of $1,000 and pays a semiannual coupon of 10%. The bond is currently priced at $1,175 and has the option to be called at $1,100 five years from now. Note that the remaining years until maturity does not matter for this calculation.
Using the above formula, the calculation would be set up as:
$1,175 = ($100 / 2) x {(1- (1 + YTC / 2) ^ -2(5)) / (YTC / 2)} + ($1,100 / (1 + YTC / 2) ^ 2(5))
Through an iterative process, it can be determined that the yield to call on this bond is 7.43%.
Bond Valuation: Solving for the Yield to Call
How is yield to call calculated?
Hypothetically, the yield to call (YTC) can be calculated as if the bond was redeemed on a date later than the first call date, but most YTCs are calculated based on redemption on the earliest date possible. What are Callable Bonds?
How is yield to call (YTC) calculated?
Yield to call (YTC) is calculated as explained above based on the available callable dates. YTM The yield to maturity refers to the expected returns an investor anticipates after keeping the bond intact till the maturity date. In other words, a bond’s returns are scheduled after making all the payments on time throughout the life of a bond.
What is a yield to call bond?
When the yield to call exceeds the yield to maturity, the bond is called, and vice versa. Second, yield to call allows investors to compare the yields supplied by callable bonds to those provided by non-callable bonds.
What is the difference between yield to maturity and yield to call?
Yield to maturity is the total return paid out when a bond is purchased until it matures. The yield to call is the amount paid if the issuer of a callable bond decides to pay it off early. As a result, callable bonds often have a higher yield to maturity.
