Yield to Worst

Definition

Yield to worst is a measure used to assess the lowest potential yield an investor can receive on a bond without default. It takes into account the possibility of the bond being called or maturing early, which could result in a lower yield than what was initially expected. This concept is crucial for investors in evaluating the risks associated with bonds, particularly those with call provisions or varying maturity dates.

5 Must Know Facts For Your Next Test

1. Yield to worst is particularly important for callable bonds, where early redemption can significantly affect the expected return on investment.
2. This metric helps investors gauge their worst-case scenario when holding a bond, providing a conservative view of potential returns.
3. Calculating yield to worst involves determining both yield to maturity and yield to call, then selecting the lower of the two.
4. Investors often use yield to worst as part of their risk assessment, especially in volatile interest rate environments.
5. Understanding yield to worst can influence investment strategies, as it allows investors to prioritize bonds with more favorable risk-return profiles.

Review Questions

• How does yield to worst differ from other yield metrics like yield to maturity and current yield?
  • Yield to worst differs from yield to maturity and current yield as it specifically focuses on the lowest potential yield an investor might receive if a bond is called early or matures sooner than expected. While yield to maturity calculates returns assuming the bond is held until it matures, current yield assesses income relative to price. Yield to worst provides a more conservative outlook, considering scenarios where returns may be less favorable due to issuer actions.
• In what situations would an investor particularly rely on yield to worst when evaluating bonds for their portfolio?
  • An investor would rely on yield to worst when assessing callable bonds or bonds in uncertain interest rate environments. These scenarios present risks where bonds may be redeemed early by issuers, potentially affecting returns. By focusing on the lowest possible yield, investors can make more informed decisions about their investment choices, ensuring they are prepared for less favorable outcomes while balancing risk and reward.
• Evaluate the implications of a rising interest rate environment on the concept of yield to worst and how it impacts bond investors' strategies.
  • In a rising interest rate environment, the implications for yield to worst become critical for bond investors. As rates increase, existing bonds with lower yields become less attractive, leading issuers to potentially call their callable bonds before maturity. This situation could result in investors receiving lower yields than initially expected, highlighting the importance of considering yield to worst in investment strategies. Investors may adjust their portfolios towards longer-duration bonds that are less likely to be called or explore alternative investments that better align with their risk tolerance and expected returns.

Related terms

Current Yield: The current yield is the annual income (interest or dividends) divided by the current price of the security, giving a snapshot of the income generated relative to the investment's market value.

Yield to Maturity: Yield to maturity is the total return anticipated on a bond if it is held until it matures, accounting for all coupon payments and the difference between the purchase price and face value.

Callable Bond: A callable bond is a bond that can be redeemed by the issuer before its maturity date at specified prices, usually beneficial to issuers when interest rates drop.