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What Is the Yield to Maturity and Yield to Call?

Original post by Diane Perez of Demand Media

A callable bond is a financial instrument that gives the issuer the right to call in its bonds for redemption before they reach maturity. This does not mean that the issuer will definitely call in the bond, or that the projected date will be an actual call date. Additionally, some bonds have multiple call dates. Therefore, investors need to calculate the yield to maturity and yield to call when considering which of these bonds to add to their portfolio.

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Yield to Maturity

Yield to maturity (YTM) is the interest a bond earns from the date of original sale until it reaches full maturity. This yield is usually higher than the yield when the issuer calls the bond early. The YTM calculation includes the assumption that you will reinvest all coupons at the same interest rate as the original bond.

Formula for Yield to Maturity

Investors use programmable business calculators to quickly ascertain if a bond meets their minimum criteria for rate of return. However, you can do the calculation with pen and paper using the formula: YTM = {C + (F - P / n)} / {F + P / 2} where: C = the total coupon or interest payment; F = the face value of the bond; P = the purchase price of the bond; and, n = the number of years until maturity.

Yield to Call

Some bond issuers never intend to pay interest on their bonds until maturity. It may be cheaper for them to call the bonds early and possibly issue a new set of bonds, rather than allow the original bonds to reach maturity. You can only estimate yield to call (YTC), as you really have no idea when or if the issuer will issue a call. For example, a 10-year bond may be callable after 4 years, so your calculation would include the 4-year date. However, the issuer may call the bond on a different day, or possibly wait until the second call date. This calculation is more complex than yield to maturity, so it is best to access one of the many online YTC calculators. You may want to calculate YTC for the first call date, or for all of them.

Yield to Worst

After calculating yield to maturity and yield to call, you will be able to identify the yield to worst. The yield to worst is the lowest yield you could possibly earn on the bond. Some prudent investors consider yield to worst when deciding whether to purchase a callable bond.


                   

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About the Author

Diane Perez is a writer who contributes to various websites, specializing in gardening and business topics, and creates sales copy for private clients. Perez holds a Bachelor of Science in education from the University of Miami.


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