Yield to Call

Definition

Yield to call is a financial metric used to measure the return an investor can expect to receive if a callable bond is redeemed by the issuer before its maturity date. This concept is essential for understanding the potential risks and rewards associated with investing in callable bonds, which have the option for the issuer to repurchase them at a predetermined price on specific dates. Investors consider yield to call in relation to the bond's coupon rate, market conditions, and interest rates when evaluating the overall attractiveness of the investment.

5 Must Know Facts For Your Next Test

1. Yield to call is calculated based on the bond's current market price, the call price, the time until the bond can be called, and the coupon payments received until that time.
2. If interest rates fall, issuers are more likely to call their bonds, which can impact the yield to call since investors might miss out on higher yields if they hold onto the bond.
3. Comparing yield to call with yield to maturity helps investors decide whether to hold onto a callable bond or sell it in the market.
4. Investors often seek bonds with a higher yield to call as a way to compensate for the risk of early redemption by the issuer.
5. Understanding yield to call is crucial for assessing the potential cash flows from callable bonds, particularly in fluctuating interest rate environments.

Review Questions

• How does yield to call differ from yield to maturity in assessing callable bonds?
  • Yield to call focuses on the return an investor can expect if a callable bond is redeemed early by the issuer, while yield to maturity calculates the total return expected if the bond is held until its maturity date. This distinction is important because callable bonds may be redeemed when interest rates decline, potentially resulting in lower overall returns than initially anticipated. Investors must evaluate both yields to make informed decisions based on their investment goals and interest rate expectations.
• What factors influence an issuer's decision to call a bond and how does this impact an investor's expected return?
  • An issuer typically decides to call a bond when interest rates decline significantly below the bond's coupon rate, allowing them to refinance at a lower cost. This impacts an investor's expected return because they may lose out on future coupon payments if their bond is called early. As such, understanding this relationship helps investors assess the risk and potential yield of callable bonds more accurately, considering market conditions and interest trends.
• Evaluate how yield to call can be utilized as a strategy for managing investment risk in callable bonds during fluctuating interest rates.
  • Yield to call serves as a crucial tool for investors looking to manage risk associated with callable bonds amid fluctuating interest rates. By calculating and comparing yield to call against other metrics like yield to maturity and current yield, investors can gauge potential returns while accounting for early redemption risks. This evaluation allows them to make strategic decisions about whether to hold or sell their bonds based on anticipated market changes and personal investment objectives, ultimately optimizing their portfolio performance.

Related terms

Callable Bond: A type of bond that allows the issuer to redeem it before its maturity date at a specified call price.

Coupon Rate: The annual interest rate paid on a bond, expressed as a percentage of its face value.

Current Yield: A measure of a bond's annual coupon payment divided by its current market price, indicating the income an investor earns relative to the price paid.