Yield to Call
Yield to Call (YTC) is the total return anticipated on a callable bond if it is held until the issuer exercises its call option on the first available call date, incorporating both coupon income and the capital gain or loss from the difference between the current price and the call price. It is analogous to yield to maturity but uses the call date and call price rather than the maturity date and par value.
Key takeaways
- YTC is relevant for bonds trading at a premium (above par), where issuers are likely to call the bond to refinance at lower rates.
- Yield to call is calculated using the same present value formula as YTM, substituting the call date for the maturity date and the call price for par.
- When market yields fall below the coupon rate, YTC becomes the relevant yield measure because the issuer will likely call the bond.
- Investors use yield to worst (YTW)—the minimum of YTM and all YTC calculations—as the most conservative yield estimate.
- Negative convexity near call prices means that callable bonds have limited price appreciation relative to equivalent non-callable bonds when rates fall.
Explanation
Yield to call is a critical analytical tool for fixed income investors evaluating callable bonds—debt securities that give the issuer the right (but not the obligation) to redeem the bond before its stated maturity at a specified call price, typically at par ($100) or at a small premium. The embedded call option benefits the issuer: if market interest rates decline below the bond's coupon rate, the issuer can call the old high-coupon bonds and refinance at the prevailing lower rates, reducing interest expense. This optionality is unfavorable for investors, who must reinvest their redeemed principal at the newly lower market rates.
The mechanics of computing YTC mirror those of YTM precisely, except that the maturity date is replaced by the first (or any specified) call date, and the redemption value is replaced by the call price. A bond with a 6% coupon, 15-year maturity, callable in 5 years at $102, currently priced at $107 would have its YTC computed as the rate that equates $107 to the present value of five years of 3% semi-annual coupon payments plus a terminal cash flow of $102 at year 5. In this case, YTC would be materially lower than YTM because the investor is receiving fewer coupon periods and recovering $102 rather than $100—but importantly, much sooner and at a higher price than par.
Bonds trading significantly above par in low-interest-rate environments are said to have 'call risk'—the risk of involuntary reinvestment at lower rates. In such environments, YTC is more economically relevant than YTM because rational issuers will almost certainly call the bonds. Conventional bond analytics quote 'yield to worst' (YTW) to provide the most conservative yield estimate: YTW is the minimum of YTM, YTC at each call date, and yield to put (for bonds with put options). CFA Institute standards and most fixed income analytics platforms compute YTW as the standard reference yield for callable bonds.
The option-adjusted spread (OAS) framework extends YTC analysis by decomposing the yield spread of a callable bond into the spread attributable to credit risk (OAS) and the spread sacrificed to the embedded call option (the option cost). A callable bond's OAS equals its yield spread over the Treasury benchmark minus the theoretical value of the embedded call option: OAS = Z-spread − Call Option Cost. This allows investors to compare callable bonds on an apples-to-apples basis with non-callable alternatives.
Formula
P = \sum_{t=1}^{T_c} \frac{C}{(1+YTC)^t} + \frac{CP}{(1+YTC)^{T_c}}
Example
A corporate bond has the following characteristics: 7% annual coupon, current market price of $108, maturity in 10 years, callable in 3 years at $103. YTM assumes the bond runs to maturity: the investor receives 10 years of $70 coupons plus $1,000 (par) at maturity; solving for the discount rate gives YTM ≈ 6.15%. YTC assumes the issuer calls in 3 years at $1,030: the investor receives 3 years of $70 coupons plus $1,030 at year 3; solving gives YTC ≈ 5.05%. Because the YTC of 5.05% is substantially lower than the YTM of 6.15%, the yield to worst is 5.05%—and this is the appropriate conservative yield measure. An investor paying $1,080 for this bond should base their expected return analysis on 5.05%, recognizing that if rates stay low, the issuer will almost certainly call the bond in three years.
Related terms
Basis Bond Call Option Callable Bond Convexity Corporate Bond Coupon Rate Credit Risk Discount Rate Option Option Adjusted Spread Par Value