Definition
Yield to Call (YTC) is a financial concept that represents the total return an investor would receive if they held a bond until its call date. The call date refers to the date when a bond issuer can redeem the bond before it reaches its maturity date. YTC takes into account both the interest payments received periodically and the capital gain or loss that would result from selling the bond on the call date.
Key Takeaways
- Yield to Call (YTC) refers to the total return an investor would receive if a bond or other interest-bearing security is held until its call date. The call date is the point in time when a bond issuer can return the principal and stop interest payments.
- Yield to Call calculation takes into account the market price, par value, coupon interest rate, and the time to call. It is particularly used in bond markets where callable bonds, having the option to be redeemed by the issuer before they reach their maturity, are issued.
- Investors use Yield to Call as a way to predict their potential income from an investment, providing a framework for comparing different types of bonds or securities. However, its calculation operates under the assumption that the bond will be called, which may not always be the case.
Importance
Yield to Call (YTC) is an important financial term as it provides potential investors or bondholders with a measure to assess the returns from their investments, should the bond be repurchased by the issuer before its maturity date.
This information is particularly valuable because many bonds come with call provisions, allowing the issuer the option to pay back the principal amount before the bond’s maturity.
Knowing the YTC helps investors predict their earnings accurately and improves their investment strategy, as bonds with high YTC are often more desirable.
Thus, it is an essential financial tool for risk evaluation and investment optimization.
Explanation
Yield to Call (YTC) serves an essential purpose in the realm of financial analysis, specifically concerning bond investment evaluations. It provides an estimate of the total returns a bond might generate if it is called, or paid off before its maturity date, considering the present market circumstances, the bond’s price, its value at maturity, and the call price.
YTC is used by investors to gauge the potential income of callable bonds (bonds that can be bought back by the issuer before they reach maturity) and then to compare it with other bonds’ yields, providing a benchmark to determine attractive investment prospects. Moreover, Yield to Call is utilized as a determining factor in the investment decision-making process, as it takes into account both the income from interest payments and the potential capital gain or loss resulting from a bond’s eventual call.
Since callable bonds pose a risk to investors due to the potential for the bond to be called in a declining interest rate environment, YTC assists in mitigating this risk by providing a measure of the lowest potential yield a bond may provide, assuming it is called at the earliest possible date. Thus, understanding Yield to Call is imperative for investors navigating the volatile landscape of callable bonds to ensure optimal investment decisions.
Examples of Yield to Call
Corporate Bonds: A large corporation, let’s say ABC Corp., issues callable bonds with a 5-year maturity period. These bonds have a call provision that the company can buy back the bonds after 3 years. The yearly coupon payment is $50 with a call price of $1,
If you buy this bond for $1,000, the Yield to Call (YTC) will be calculated based on the interest received and the price when the company calls back the bond.
Municipal Bonds: A local government issues a bond with a 10-year maturity period and includes an option to call the bond after 5 years. The bond has a face value of $5,000, a coupon rate of 5%, and a call price of $5,
If an investor buys this bond at a premium or higher than its face value, they might end up getting a lower Yield to Call as the bond might be called by the municipality before the maturity date.
Mortgage-backed securities: A financial institution issues a Mortgage-Backed Security (MBS) with a certain yield. However, the MBS includes a provision that it can be called if the underlying mortgages are paid off sooner than expected. In this case, the Yield to Call would include not only the interest payments, but also any capital gains or losses from the difference between the purchase price and the call price. The overall yield will depend on how long the security is held before it’s called.
Frequently Asked Questions about Yield to Call
What is Yield to Call?
The Yield to Call (YTC) is a financial concept that refers to the total return an investor would receive if the bond or other fixed-income securities are held until the call date.
How does Yield to Call work?
Yield to Call works by considering potentially lost interest from callable bonds. Callable bonds have the possibility of being taken back by the issuer before the maturity date. The YTC calculates the return if this happens on the next call date.
How is Yield to Call calculated?
Yield to Call is calculated using the coupon payment, the call price, the time until the call date, and the current market price. It helps to determine whether a callable bond would be a profitable investment.
What is the difference between Yield to Call and Yield to Maturity?
While Yield to Maturity refers to the return if a bond is held until its maturity, Yield to Call refers to the return if a bond is held until its call date.
What factors can affect Yield to Call?
Many factors can affect Yield to Call including interest rates, the time until the call date, the bond’s call price, and the bond’s current price on the market.
Related Entrepreneurship Terms
- Call Date
- Call Premium
- Callable Bond
- Interest Rate Risk
- Coupon Rate
Sources for More Information
- Investopedia: A comprehensive online resource that defines and explains a wide range of finance terms including Yield to Call.
- Morningstar: A leading provider of independent investment research that covers an extensive range of finance-related topics such as Yield to Call.
- Fidelity: An international brokerage that offers a range of investing insights, educational materials and tools pertaining to finance subjects, including Yield to Call.
- The Balance: Provides a vast array of personal finance and money-related content, offering articles and explanations of concepts like Yield to Call.
