Yield to Call

The yield to call — or YTC — is the total annual return an investor earns on a callable bond if the bond is called (redeemed early) on the first call date at the call price. YTC is typically lower than yield to maturity because callable bonds are usually called when interest rates fall, limiting the bondholder’s upside. YTC is the relevant return metric for premium (above-par) callable bonds where calling is likely.

Calculation and relationship to yield to maturity

YTC is calculated identically to yield to maturity — as the discount rate equating the bond’s price to future cash flows — except the terminal cash flow is the call price on the call date, not the face value at maturity.

For a bond purchased at $1,050 (premium) with a 5% coupon, call date in 5 years at a call price of $1,025:

• Yield to maturity = return if the bond is held to maturity (matures after, say, 10 years)
• Yield to call = return if the bond is called in 5 years at $1,025

The YTC is lower than yield to maturity because the bondholder receives only $1,025 in 5 years instead of $1,000 in 10 years, plus the opportunity for future coupon reinvestment is lost.

When bonds are called

Callable bonds are called when interest rates fall and the issuer can refinance at lower cost. If a corporation issued 6% bonds when rates were 6%, and rates subsequently fell to 4%, the corporation can call those 6% bonds, issue new 4% bonds, and save 200 basis points on its coupon payments.

The bondholder, having bought at par or above, receives a call notice, receives the call price, and must reinvest the proceeds in a lower-rate environment.

Premium bonds and call risk

A premium bond (trading above par) is at risk of being called. If a bond was issued with a 6% coupon and rates subsequently fell to 3%, the bond trades at a premium (perhaps $1,150) as new buyers value the high coupon.

If the call price is $1,050, the bondholder faces a dilemma:

• If called, they receive $1,050 and lose the upside from owning a discounted security (bought at $1,150).
• If not called, they keep the 6% coupon, which is attractive in a 3% rate environment.

The YTC calculation assumes the bond is called, capping the bondholder’s upside. For premium bonds, YTC is the conservative return estimate.

Discount bonds and call option value

A discount bond (trading below par) has limited call risk because the call price is typically par or above. If a bond is trading at $900 (discount to par $1,000) and the call price is par, calling it is unattractive to the issuer.

For discount bonds, yield to maturity is the relevant metric. YTC would be meaningless or artificially high.

Negative yield-to-call

In rare scenarios where the call price is below the bond’s current price, YTC can be negative. This occurs when the bond is deeply in-the-money for calling and trading at an extreme premium. This is unusual.

“Yield to worst” and the conservative approach

Rather than calculating YTC for the first call date, some investors calculate “yield to worst” — the lowest possible return considering all potential redemption scenarios (call dates, put dates, maturity).

For a bond with multiple call dates, yield-to-worst would be the lowest YTC or the YTM, whichever is lower. This provides a conservative return estimate.

Use in bond analysis

Bond traders and investors use YTC heavily when evaluating premium callable bonds. A bond trading at $1,100 (premium) with a 6% coupon and a first call date in 3 years might have:

• Yield to maturity = 4.5% (if maturity is in 10 years)
• Yield to call = 3.2% (if called in 3 years)

The investor must decide whether to assume calling (3.2% return) or holding to maturity (4.5% return). The bond’s relative value depends on the probability of calling — if rates are likely to fall further, calling is likely, and 3.2% is the expected return.

Refinancing and issuer motivation

An issuer’s decision to call depends on refinancing economics. If the call price is $1,050 and the bond is callable in 3 years at that price, the issuer will refinance only if new borrowing costs are sufficiently low to justify paying $1,050 for the bond and issuing new debt.

Typically, issuers refinance when they can lower their coupon by at least 100 basis points, covering the costs and effort of refinancing.

See also