Yield to call
What is the yield to call?
Yield to call (YTC) is a financial term that refers to the yield a bondholder receives if the bond is held until the call date, which occurs sometime before its maturity. This number can be calculated mathematically as the compound interest rate at which the present value of a bond’s future coupon payments and the purchase price equal the bond’s current market price.
The call yield applies to callable bonds on hold, which are debt instruments that allow bond investors to redeem the bonds – or the bond issuer to redeem them – provided the call date is called, at a price known as the call price. definition, the redemption date of a bond occurs chronologically before the maturity date.
IMPORTANT POINTS
The term "call yield" refers to the yield a bondholder receives if the security is held to the call date, before its maturity date. Call yield applies to callable bonds, which are securities that allow bond investors to redeem bonds (or the bond issuer to redeem them) early, at the price of 'purchase. Call performance can be calculated mathematically using computer programs. The return to the call is the return on investment for a fixed income holder if the underlying security, that is, the obligation of appeal is held up to the predetermined appeal date Since these bonds offer investors an additional redemption feature of the bond on a redemption date (at a predetermined purchase price), they require a relatively higher premium.
Understanding the yield to buy back
Many bonds are callable, especially municipal and corporate bonds. If interest rates fall, the company or municipality that issued the bond may choose to pay off the outstanding debt and obtain new financing at a lower cost.
The calculation of the yield for the call of such bonds is important because it reveals the rate of return that the investor will receive, assuming:
The bond is called on the earliest possible date
The bond is purchased at the current market price
The bond is maintained until the date of the call
Calculating Yield-To-Call
Although the formula used to calculate the yield to call looks slightly complicated at first glance, it is quite straightforward.
The complete formula to calculate yield to call is:
P = (C / 2) x {(1 – (1 + YTC / 2) ^ -2t) / (YTC / 2)} + (CP / (1 + YTC / 2) ^ 2t)
Where:
P = the current market price
C = the annual coupon payment
CP = the call price
t = the number of years remaining until the call date
YTC = the yield to call
Based on this formula, the yield to call cannot be solved for directly. An iterative process must be used to find the yield to call if the calculation is being done by hand. Fortunately, many computer software programs have a “solve for” function that’s capable of calculating such values, with a click of the mouse.
Important Notes
Although yield to maturity (YTM) is a very popular measure used to calculate the rate of return on bonds, for callable bonds this calculation becomes a bit complex and can be misleading. an additional characteristic of a bond called by the issuer at its convenience. it makes sense to calculate both parameters and prepare for the worst-case scenario.
The call efficiency (YTC) is calculated as explained above based on the available call dates.
The yield to maturity (YTM ) is calculated assuming that the bond is never redeemed during its term and that it is held to maturity.
Some Thumb Rules
YTC> YTM: it is in the investor’s interest to opt for redemption.
YTM> YTC: It is advantageous to keep the board until the expiration date.
The calculation of return on call focuses on three aspects of return for an investor. These sources of potential return are coupon payments, capital gains and the amount reinvested. The whole calculation is based on assumptions around these three important attributes of fixed-income securities.
However, most analysts find it inappropriate to assume that the investor can reinvest the coupon payments at the same rate or a lower rate. higher rate. Moreover, assuming that the investor will hold the bond until the redemption date, is also incorrect and may lead to misleading results when used for the investment calculation.
The yield of A bond redeemable at a given price until maturity of the bond will always be lower than the yield to maturity.
Thus, if interest rates fall, the price of a callable bond will rise, but only to a certain extent relative to a vanilla bond which has no upside potential. The reason is simple: the issuer will take care of the underlying security and only call it back when it can reissue it at a lower interest rate. This makes perfect sense as bonds should only be called declining interest rates, and therefore only refinancing will make sense.
Components of Yield to Call
To sum up, Yield Call calculations are important because they help the investor assess return on investment, he will assume the following factors
- Bond is held to date predetermined call and not the maturity date
- The purchase price of the bond is assumed to be the current market price rather than the face value of the bond
- Although there may be multiple redemption dates, The obligation is assumed to be calculated on the earliest possible date.
Conclusion
Purchase yield is one of the prudent ways an investor can prepare for volatility in interest rates. Although it is calculated based on the first call date, many investors calculate the return on all of the dates on which the issued security can be called. Based on this, they decide on the worst possible outcome and this derivative return is called the worst computational return.
