Yield to Call (YTC)¶
Yield to Call (YTC) is an important concept in bond investing when considering bonds that can be redeemed before their scheduled maturity date. This measure calculates the expected return on a bond if it is called (redeemed early) by the issuer under the terms specified in the bond's prospectus.
Overview¶
Bonds with a call option provide the issuer the right to redeem the bond before it reaches maturity. For investors, it's crucial to calculate not only the Yield to Maturity (YTM) but also the Yield to Call (YTC), especially for bonds where the call option might be exercised depending on market conditions.
Calculation of YTC¶
YTC is calculated similarly to YTM, except that the cash flows are considered only up to the call date rather than the full maturity date.
Formula¶
The formula to calculate YTC is as follows:
\(Market\ Price = \sum (\frac{Coupon\ Payment}{(1 + r)^t}) + \frac{Call\ Price}{(1 + r)^{N'}}\)
Where:
- r is the YTC as a decimal,
- t is each time period up to the call date,
- N' is the total number of periods until the call date,
- Coupon Payment is the periodic interest payment,
- Call Price is the price at which the issuer can redeem the bond before maturity,
- Market Price is the current selling price of the bond.
Considerations¶
- Cash Flows: Includes all coupon payments until the call date and the call price paid when the bond is redeemed.
- Call Date: The specific future date when the issuer might choose to redeem the bond before its maturity.
Comparing YTC and YTM¶
Investors should consider both YTC and YTM when evaluating callable bonds:
- If YTC > YTM: It suggests that it would be advantageous for the investor to have the bond called, as the return until the call date is higher than if held to maturity.
- If YTM > YTC: Holding the bond until final maturity is more beneficial because the yield assuming full-term holds is higher than if the bond is called earlier.
Importance of YTC¶
- Risk Assessment: YTC provides a measure of the early redemption risk and potential returns if the issuer decides to call the bond.
- Investment Strategy: Helps in making informed decisions about buying callable bonds based on potential early exit yields.
- Pricing: Influences the market pricing of callable bonds, as the call feature adds an additional layer of complexity to the bond's valuation.
Conclusion¶
Understanding Yield to Call is essential for investors in callable bonds to assess the impact of early redemption on their investment returns. YTC offers a way to evaluate the attractiveness of bonds where the issuer has the option to redeem before maturity, affecting the overall yield received by the investor.
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