Yield to call (YTC) is a financial calculation used to determine the yield or return on a bond that can be obtained if the bond is called or redeemed by the issuer before its maturity date. It represents the annualized rate of return an investor would achieve if a callable bond is bought at its current market price and held until its call date. The YTC takes into account both the bond’s coupon rate and the difference between its market price and the bond’s call price.
Explanation:
When a bond is issued, it typically has a set maturity date at which the investor will receive the principal payment and the bond will cease to exist. However, in some cases, the issuer may have the option to call the bond back before its maturity date, usually to take advantage of lower interest rates or to refinance the debt. The callable bond will have a call date and a call price, which is the price at which the issuer can redeem the bond early.
YTC is an important metric for investors because it helps them understand the potential yield they may earn if the bond is called and the investor’s investment is returned before maturity. Since callable bonds tend to have higher yields than non-callable bonds to compensate for the uncertainty of early redemption, YTC gives investors an estimate of the bond’s yield under different scenarios.
Calculation:
To calculate YTC, the following variables are required:
- Current market price: The market price at which the bond is purchased.
- Coupon rate: The annual interest rate paid by the bond.
- Call date: The date when the bond can be called back by the issuer.
- Call price: The price set by the issuer at which the bond can be called back.
Using these variables, the YTC can be calculated using a financial calculator or a spreadsheet program. The calculation involves finding the yield that equates the present value of the bond’s cash flows (coupons and face value) to its current market price. This yield represents the annualized return if the bond is called at the call date.
Significance:
YTC provides investors with valuable information when assessing callable bonds. By considering the potential call date and call price, investors can evaluate whether the yield offered by a callable bond meets their investment objectives. A higher YTC implies a higher return if the bond is called, which may be attractive to investors seeking higher yields. However, it is important to note that the actual yield earned may differ if the bond is not called or if it is called earlier or later than expected.
YTC can also be compared to the yield to maturity (YTM) to analyze the risk-reward ratio of a callable bond. YTM represents the yield if the bond is held until its maturity date, disregarding potential early redemption. By comparing YTC and YTM, investors can assess the impact of possible call scenarios on their overall investment strategy.
Overall, the YTC metric aids investors in making informed decisions by quantifying the potential return of a callable bond if it is called before its maturity date. By understanding the relationship between YTC, current market price, call date, call price, and coupon rate, investors can gauge whether a particular bond fits their risk appetite and investment goals.
