Definition
Yield to Call (YTC) is the yield on a bond or other fixed-income security that investors would receive if the bond is redeemed by the issuer on the first call date specified in the bond’s indenture agreement. The yield to call calculation assumes that the issuer will exercise its option to call the bond at that date, paying back the face value of the bond and sometimes a call premium. This metric is crucial for investors holding callable bonds, as it provides insight into the potential returns of the bond if called before its maturity date.
Examples
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Callable Corporate Bond:
A corporate bond with a face value of $1,000, a coupon rate of 5%, and a call feature allows the issuer to redeem the bond in five years. If the bond was purchased at a premium of $1,050 and the issuer decides to call it in five years, the yield to call will incorporate the call price and the remaining interest payments until the call date.
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Municipal Bond:
A municipal bond issued by a city government with a 4% coupon rate and a call option after ten years. If interest rates decline significantly, the city may call the bond to refinance at lower rates. The YTC helps investors know the yield they will earn if the bond is called at the ten-year mark.
Frequently Asked Questions
Q1: What is the difference between Yield to Call (YTC) and Yield to Maturity (YTM)?
Yield to Call assumes the bond will be called at the earliest call date, while Yield to Maturity assumes the bond will be held until its maturity date. YTC considers the call premium and the shorter investment period, unlike YTM which considers the full term of the bond.
Q2: Why is Yield to Call important to investors?
Yield to Call is important because it helps investors understand the potential return if the bond is called before maturity, allowing them to make more informed investment decisions, especially in a declining interest rate environment where issuers are likely to call bonds to refinance at lower rates.
Q3: How do call premiums affect the Yield to Call?
Call premiums, which are extra amounts paid by the issuer when calling the bond, affect the Yield to Call by increasing the bondholder’s return. Higher call premiums generally result in a higher yield to call.
Q4: Can Yield to Call be lower than Yield to Maturity?
Yes, Yield to Call can be lower than Yield to Maturity, especially if the bond is purchased at a premium or if the call date is near. The shorter time horizon for YTC compared to the full term for YTM can lead to a lower yield.
- Callable Bond: A type of bond that allows the issuer to redeem the bond before its maturity date under specified conditions.
- Indenture Agreement: The formal agreement between a bond issuer and bondholders, detailing the terms of the bond, including any call features.
- Coupon Rate: The annual interest rate paid by the bond issuer, typically expressed as a percentage of the face value.
- Call Premium: An added amount paid by the issuer to bondholders when exercising the option to call the bond before its maturity date.
Online Resources
Suggested Books for Further Studies
- “The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau
- “Bond Markets, Analysis and Strategies” by Frank J. Fabozzi
- “Fixed Income Analysis” by CFA Institute
Fundamentals of Yield to Call: Finance Basics Quiz
### What does Yield to Call (YTC) indicate?
- [ ] The coupon rate of the bond
- [x] The yield if a bond is called at the earliest call date
- [ ] The yield if a bond is held to maturity
- [ ] The amount of the call premium
> **Explanation:** Yield to Call indicates the yield investors would receive if the bond is called at the earliest call date as specified in the indenture agreement.
### How does Yield to Call (YTC) differ from Yield to Maturity (YTM)?
- [x] YTC assumes the bond is called at the earliest call date, while YTM assumes the bond is held till maturity
- [ ] YTM is usually lower than YTC
- [ ] YTM does not consider call premiums whereas YTC does
- [ ] YTC is based on the coupon rate only
> **Explanation:** YTC assumes the bond will be called at the earliest call date and incorporates the call premium and shortened time period, unlike YTM which assumes the bond is held until its full maturity.
### Why might an issuer call a bond?
- [ ] Because the bondholders request it
- [ ] To refinance at higher interest rates
- [x] To refinance at lower interest rates
- [ ] To increase the bond’s coupon rate
> **Explanation:** Issuers might call a bond to refinance at a lower interest rate, thus reducing their cost of borrowing.
### What is a callable bond?
- [ ] A bond that can be sold back to the market at any time
- [ ] A bond that pays interest annually
- [x] A bond that the issuer can redeem before its maturity date
- [ ] A bond without an indenture agreement
> **Explanation:** A callable bond allows the issuer the option to redeem the bond before its maturity date under specified conditions detailed in the indenture agreement.
### What role does the indenture agreement play in Yield to Call?
- [x] It specifies the terms of the bond, including the earliest call date
- [ ] It sets the coupon rate and face value
- [ ] It determines the market price of the bond
- [ ] It is where bond issuers specify the investors' contact information
> **Explanation:** The indenture agreement is crucial as it contains all the terms and conditions of the bond, including the earliest call date, which is necessary for calculating Yield to Call.
### How does a call premium influence Yield to Call?
- [ ] It decreases the yield because of additional costs
- [x] It increases the yield as it is an extra payment to bondholders
- [ ] It does not affect the yield
- [ ] It’s irrelevant to the calculation of YTC
> **Explanation:** A call premium is an additional amount paid to bondholders, increasing the Yield to Call and providing higher return if the bond is called.
### Why might an investor be interested in knowing the Yield to Call of a bond?
- [ ] To predict the bond's face value at maturity
- [x] To understand potential returns if the bond is called early
- [ ] To avoid investing in callable bonds
- [ ] For understanding interest payments made by the issuer
> **Explanation:** Knowing the Yield to Call helps investors understand potential returns if the bond is called early, which is crucial for investment decisions in callable bonds.
### Can a callable bond's YTC be higher than its YTM?
- [ ] Yes, always
- [ ] No, never
- [x] Yes, in some cases
- [ ] It depends on the bond's coupon rate
> **Explanation:** Though it's less common, a callable bond's YTC can be higher than its YTM, especially if the bond's market price is very low or has a high call premium.
### What happens to a bondholder's yield if a bond is called earlier than expected?
- [ ] The yield is unaffected
- [ ] The bondholder always suffers a loss
- [ ] The bondholder receives the same total interest as if held to maturity
- [x] The bondholder’s future yield is limited by the call
> **Explanation:** If a bond is called earlier, the bondholder's future yield is limited by the call, changing the return they would have earned if held to maturity.
### In what scenario is Yield to Call particularly relevant?
- [x] When investing in callable bonds
- [ ] When dealing with zero-coupon bonds
- [ ] When investing only in stocks
- [ ] When forecasting a company's equity growth
> **Explanation:** Yield to Call is particularly relevant for investors in callable bonds as it provides insight into the returns if the issuer opts to call the bond before maturity.
Thank you for exploring the concept of Yield to Call and testing your knowledge with our finance quiz! Keep deepening your understanding of fixed-income securities to make well-informed investment decisions.
