What is Yield To Call?
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Yield to call (YTC) is a financial term that refers to the return a bondholder receives if the bond is held until the call date, which occurs sometime before it reaches maturity. This number can be mathematically calculated as the compound interest rate at which the present value of a bond's future coupon payments and call price is equal to the current market price of the bond.Yield to call applies to callable bonds, which are debt instruments that let bond investors redeem the bonds—or the bond issuer to repurchase them—on what is known as the call date, at a price known as the call price. By definition, the call date of a bond chronologically occurs before the maturity date.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.
Definition
Yield to Call (YTC) refers to the return a bondholder receives if the bond is held until the call date, before its maturity. This figure is calculated by equating the present value of the bond's future coupon payments and the call price to the bond's market price.
Origin
The concept of Yield to Call emerged with the development of the bond market, particularly after the introduction of callable bonds. Callable bonds allow issuers to redeem the bonds at a predetermined price before a specified date, a mechanism that became popular in the early 20th century to help issuers manage interest rate risk.
Categories and Features
Yield to Call primarily applies to callable bonds. Callable bonds are debt instruments that allow bondholders to redeem the bond at a known call price on the call date. Features include: 1. Flexibility of early redemption; 2. Typically called at a premium slightly above face value; 3. Call price is based on current market interest rates. The advantage of callable bonds is that they offer investors the opportunity to lock in returns when interest rates fall, but they also face the risk of being called when rates rise.
Case Studies
Case Study 1: Suppose a company issues a batch of callable bonds with a face value of $1,000 and a coupon rate of 5%. When market rates drop to 3%, the company decides to call the bonds at $1,050 on the call date. Investors can determine their actual returns using the yield to call calculation. Case Study 2: Another company chooses not to call its bonds when market rates rise to 6%, allowing investors to hold the bonds until maturity and enjoy higher coupon payments.
Common Issues
Common issues investors face when applying yield to call include: 1. How to accurately calculate yield to call? 2. How to assess call risk amid fluctuating market rates? A common misconception is that yield to call is the same as yield to maturity, but yield to call considers the possibility of early redemption.
