Definition
Yield to Call (YTC) is a financial term that refers to the total return an investor would receive on a bond if they held it until its call date. The call date is when the issuer of the bond can choose to pay off the principal and cease making interest payments. YTC takes into account the bond’s current market price, its par value, annual interest payments, and the time until the call date.
Phonetic
The phonetic pronunciation of the keyword “Yield to Call” is:Yield – /jiːld/to – /tuː/ or /tə/Call – /kɔːl/Pronounce it together: /jiːld tuː kɔːl/
Key Takeaways
- Yield to Call (YTC) is an estimate of the return an investor would receive if they held a bond until the call date, at which the issuer has the option to redeem the bond prior to its maturity date.
- YTC is particularly relevant for callable bonds, as it helps investors determine the bond’s potential return under the early redemption scenario and assists in the comparison of bonds with different call features.
- Calculating Yield to Call involves estimating the bond’s future cash flows and considering the potential call price, rather than the face value, hence reflecting the potential opportunity cost for the investor due to the bond being redeemed early.
Importance
The Yield to Call (YTC) is an important term in business and finance as it allows investors to estimate the return on a callable bond if it is held until its call date, rather than until its maturity. Callable bonds provide issuers the option to redeem the bond earlier than its maturity date, usually at a predetermined call price. By calculating the YTC, investors can determine if a callable bond provides a desirable return in comparison to other investments, considering the potential risk of the bond being called away before maturity. This measure can impact investors’ decisions on whether to invest in a specific bond and build strategies around the potential cash flow and capital appreciation from these bonds. In summary, Yield to Call helps investors better evaluate and manage their investment portfolios in the context of changing interest rate environments and issuer actions.
Explanation
Yield to Call (YTC), as a crucial financial metric, serves a significant purpose in the realm of investing, specifically in bond markets. It helps investors assess the potential profitability and risk associated with callable bonds – debt securities that grant the issuer the right to redeem the bond before its maturity date at a specified call price. In essence, YTC measures an investor’s expected return if they hold onto the bonds until its issuer exercises the call option. By evaluating this return, investors are able to make more informed decisions when comparing callable bonds with other investment opportunities available in the market.
Considering the uncertain nature of an issuer recalling their bonds, the Yield to Call becomes a valuable tool for bond investors to evaluate the bond’s performance when there is a considerable likelihood of early redemption. Callable bonds typically occur when the interest rates decline; the issuer recalls the bond to refinance the debt at a lower rate. Comparing YTC with Yield to Maturity (YTM), which considers the bond held to maturity, offers investors an insight into various yield scenarios. Consequently, this allows them to balance their investment portfolios by allocating funds to mandatory, investment-grade, and high-yield callable bonds to optimize risk-adjusted returns. In conclusion, Yield to Call is essential in helping investors gauge the worthiness of callable bonds in their overall investment strategies, particularly when interest rates fluctuate.
Examples
Example 1: A Corporate Bond – XYZ Corporation issues a $1,000 face value bond with a maturity period of 10 years and a coupon rate of 5%. The bond has a 5-year call provision, meaning the company can call (repurchase) the bond after 5 years at a call price of $1,050. An investor purchases the bond for $980. The yield to call for this bond will take into account the interest payments, the difference between the purchase price and the call price, and the shortened life of 5 years due to the call provision.
Example 2: A Municipal Bond – A local government issues a municipal bond with a face value of $5,000, an annual interest payment of 3%, and a call date in 7 years. The bond matures in 15 years. An investor purchases the bond for $4,800. The yield to call for this bond would consider the tax-free interest payments, the difference between the purchase price and the call price, and the potential for the bond to be called by the local government after 7 years instead of running its full 15-year maturity.
Example 3: A Callable Preferred Stock – A company issues a callable preferred stock with an annual dividend rate of 8%, a par value of $100, and a call date in 5 years. The preferred stock’s call price is set at $105. An investor buys the preferred stock for $95. In this case, the yield to call calculation would analyze the annual dividend payments, the difference between the purchase price and the call price, and the possibility that the company might call back the preferred stock after 5 years.
Frequently Asked Questions(FAQ)
What is Yield to Call?
Yield to Call (YTC) refers to the total return an investor can anticipate on a bond when it is held till its call date. A call date is a date on which the issuer has the right to redeem the bond before its maturity date.
How is Yield to Call calculated?
The calculation of YTC considers the bond’s current price, annual interest payment (coupon), the call price, and the time remaining until the call date. The formula to calculate YTC is:Yield to Call = ((Annual Interest Payment + ((Call Price – Current Price) / Years Until Call Date)) / ((Call Price + Current Price) / 2))
What is the difference between Yield to Call and Yield to Maturity (YTM)?
Yield to Call is the yield expected on a bond when it is held until its call date, while Yield to Maturity is the yield when the bond is held until its maturity date. YTC is particularly relevant for callable bonds, whereas YTM is applicable to non-callable bonds or when discussing potential total returns in the absence of a call.
When is Yield to Call used?
Yield to Call is typically used for callable bonds or securities with embedded call options. It allows investors to estimate the bond’s return if it is redeemed by the issuer on the call date, rather than at maturity. This helps in making better investment decisions.
What are some limitations of Yield to Call?
The limitations of Yield to Call include the following:1. In instances where a bond has multiple call dates, the YTC calculated for the earliest call date may not be the most accurate depiction of potential returns.2. YTC assumes that the issuer will call the bond on the call date, but the issuer may choose not to call the bond depending on prevailing market conditions.
How does callable feature impact bond pricing?
Callable bonds provide the issuer an advantage to redeem the bond before maturity, typically when market interest rates go lower. This callable feature is advantageous for issuers, but less favorable for investors since they will lose out on higher yields. As a result, callable bonds are generally offered with a higher coupon rate or lower price compared to non-callable bonds to compensate for this risk to investors.
Related Finance Terms
- Call provision
- Callable bonds
- Call premium
- Bond duration
- Interest rate risk
