What is ask yield to worst?

If a bond with a call feature is redeemed at the earliest date without defaulting, then the expected return would be the yield to worst (YTW).

The yield to worst represents the lowest potential yield that a bondholder could receive on a callable bond – assuming the issuer does not default.

Certain types of bond issuances are “callable,” meaning that the issuer has the option to redeem them before the stated maturity date, i.e. pay the debt off earlier.

Within the debentures of such bonds, the earliest date the callable feature is permitted will be clearly stated, along with details regarding any side fees incurred.

As worst-case scenario contingency planning, bondholders often estimate the yield to worst (YTW) – but to clarify, “worst-case” in these cases refers to the bond being redeemed by the issuer at the earliest possible date, rather than the yield on a bond that has defaulted.

From determining the yield to worst (YTW), bondholders can mitigate their downside risk better to reduce the odds of being blindsided by an issuer calling a bond before it matures.

The yield to worst (YTW) on a callable bond is the lower return between the yield to maturity (YTM) and the yield to call (YTC).

In the first step, the yield to maturity (YTM) and yield to call (YTC) can be calculated using the built-in “YIELD” Excel function.

The inputs within the formula are as follows:

In the subsequent step, the “MIN” function picks the lower value between the YTM and YTC, i.e. the yield to worst (YTW) of the bond.

The general rule of thumb is that interest rates and yield have an inverse relationship.

However, there are more moving pieces to consider for callable bonds, so the prior statement is not necessarily true or false without further context.

More specifically, the issuer could view the low-interest rate environment as an opportunity to refinance its existing debt at more favorable rates.

Most bonds are structured with prepayment fees as compensation for the following:

In real life, the yield to worst (YTW) is applicable only for callable bonds and those trading at a premium.

If we assume there are two identical bonds – with the only difference being that one is “callable” whereas the other is “non-callable” – then the callable bond is more likely to be negatively impacted.

Why? The chance of bonds being called tends to increase if interest rates fall and drop lower compared to when the original issuance occurred.

If interest rates decline, the issuer can be incentivized to redeem the bonds, making the callable feature unfavorable for the bondholder.

Calculating the yield to worst (YTW) is most relevant for premium bonds (i.e. “trading above par”), given how they are directly tied to collapsing interest rates.

We’ll now move to a modeling exercise, which you can access by filling out the form below.

In our illustrative exercise, we’ll calculate the yield on the bond under three different pricing scenarios.

Suppose the bond issuance has a maturity of ten years and was finalized on 12/31/2021 with the first call date 12 months after the settlement date.

At a par value of $1,000 (i.e. “100”), the three prices for each scenario are as follows:

As for the coupon, we’ll assume that the bond pays an annual coupon at an interest rate of 6%.

Now, we’ll enter our assumptions into the Excel formula from earlier to calculate the yield to maturity (YTM):

In contrast, the YTC switches the “maturity” to the first call date and “redemption” to the call price, which we’ll assume is set at 104.

The call price of 104 is the quoted price the bond issuer must pay to redeem the debt issuance entirely (or partially) before the maturity date.

Side Note: From the italics, we can identify which parts of the formula were adjusted in the YTC calculation.

If the bond trades at a discount or par, the yield to maturity (YTM) is lower than the yield to call (YTC) – which is why the yield to worst (YTW) is the yield to maturity (YTM).

However, if the bond trades at a premium, the contrary is true, where the YTC is the lower between the two yield metrics and can be considered the YTW.

Yield to call is a calculation that determines possible yields if a bond can be called by the issuer, reducing the amount of money the investor receives because the bond is not held to maturity.

To understand yield to call (or YTC), it’s necessary first to understand what a callable bond is. A callable bond is one that an issuer—usually a corporation or municipality—can redeem or “call away." In other words, they can pay it off before the bond’s maturity date.

Some callable bonds can be called at any time. Others can only be redeemed after a fixed period. For example, a 30-year callable bond could be called after 10 years have elapsed. Callable bonds typically carry higher yields than non-callable bonds because the bond can be called away from an investor if interest rates fall.

The advantage to the issuer is that the bond can be refinanced at a lower rate if interest rates are dropping. The disadvantage from the investor's perspective is that because the bond is more likely to be called when interest rates are low, the investor would have to reinvest the money at the current lower interest rate.

To calculate the YTC for a bond, its information needs to be used in this formula:

For instance, if you wanted to calculate the YTC for the following bond:

In this example, you'd receive two payments per year, which would bring your annual interest payments to $1,400.

Note that the investor receives a premium over the coupon rate; 102% if the bond is called. This is often a feature of callable bonds to make them more attractive to investors.

A bond's yield-to-call is the estimated yield an investor receives if the bond is called by the issuer before its maturity.

The yield to maturity is the yield an investor would receive if they held the bond to the maturity date. This is a similar calculation to the yield to call, except that you don't use the call price—the face value is used.

You then compare the yields and determine which is the lowest.

An investor would want to judge the bond based on its yield to call when it's likely to be called away rather than its yield to maturity. This is because it's unlikely to continue trading until its maturity.

The rule of thumb when evaluating a bond is to always use the lowest possible yield. This figure is known as the “yield to worst." To determine the lowest price, compare the two calculations.

If the bond is...

...then yield to call is the appropriate figure to use. Assume a bond is maturing in 10 years and its yield to maturity is 3.75%. The bond has a call provision that allows the issuer to call the bond away in five years. When its yield to call is calculated, the yield is 3.65%.

In this case, 3.65% is the yield-to-worst, and it's the figure investors should use to evaluate the bond. Conversely, if the yield to maturity were the lower of the two, it would be the yield-to-worst.

Calculating yield to worst Before you start, you'll need to have some information handy, including:

Now, figure out the bond's current annual interest rate based on the price you paid. You can do this by dividing the annual interest payment by the price you paid, or current market value of the bond. Then, multiply by 100 to convert to a percentage.

This is the bond's yield each year based solely on interest payments. So, to find the yield over the remaining life of the bond, multiply this rate by the number of years remaining. Do the same for each call date.

Next, you need to determine the yield that comes from the bond's market price by subtracting the price you paid from the bond's face (par) value. Divide this by the bond's face value and multiply by 100. Keep in mind that this yield can be negative if you paid more than face value for the bond.

Finally, add the two types of yield -- interest rate and bond price -- for each of the possible call dates as well as the maturity dates. Divide by the number of years to convert to an annual rate. The lowest rate is the yield to worst for your bond.

An example Let's say you buy a bond with a par value of $1,000 and a coupon rate of 5%, and that you paid $1,030 for it. And we'll say that the bond matures in five years, with possible call dates in two years and four years.

Based on this information, we can see that the bond pays $50 per year. So we can calculate its current interest rate like this:

If the bond is held to maturity, five years of interest would produce a 24.25% total yield. Or, if the bond was called after two or four years, you would have a total yield of 9.7% or 19.4%.

Next, since you bought the bond for a premium, we need to account for this contribution to the total yield.

Finally, we can calculate the yield to worst using a table like this and comparing the annual yields of each call date:

Note: This calculation assumes the bond's annual dividends are not reinvested each year. If this is the case, a new annual interest payment would need to be calculated for each year, and the then-current market price of the newly acquired bonds would need to be taken into account.

So, in this case, the first possible call date would produce the worst possible yield. As a bond investor, this is an important number to use when contemplating an investment, as it tells you the lowest possible yield (other than a default) you can expect.

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The yield to worst is the term used to describe the lowest possible yield from purchasing a bond apart from the company defaulting.

How is the yield to worst different than the yield to maturity?  It is different in that it describes a yield or rate of return, that if the bond is "called" during the term of ownership, it will create a rate of return lower than the yield to maturity.  What does "called" mean?  A bond getting called is something that can happen when a company redeems the bond before the maturity date.

The yield to worst is something that a bond investor needs to be aware of.  That's because it presents a risk if they are expecting to hold the bond until maturity.  For example, let's say the investor expects to receive a 5 percent yield to maturity.  However, if the bond gets called at the first possible call date, they will receive a 3 percent yield to worst instead.  There are no guarantees that the bond will get called, but it's a risk that the investor must keep in mind.  Later in the article, we will look at what causes a bond to get called.

We just spoke about what causes the yield to worst to be possible.  It's when a bond has the potential to be called or is callable.  But why would a bond get called?  A bond will usually get called when interest rates become lower than when the bond was initially issued.  Let's say that the company issued a bond that paid a coupon of 5%, and now interest rates have lowered significantly.  If the company can now issue bonds paying a 4% coupon, then they will likely call the 5% coupon bond and reissue at the 4% coupon rate.

Both yield to call and yield to worst is calculated based on when a bond becomes callable.  So what's the difference?  Yield to call can potentially be a higher or lower yield than the yield to maturity, depending on if the bond gets purchased at a premium or a discount to the par value.  Rather, yield to worst will always be lower than the yield to maturity because it is calculated for bonds that get purchased at a premium to par value.

John wants to buy a bond that is selling in the market for $1,100.  The coupon rate is 6% meaning it pays $60 in coupon payments annually.  The bond is callable in 2 years but John plans to hold the bond until maturity which is in 10 years.  By using a yield to maturity calculator, it is calculated that the YTM is 4.72%.  However, if John's bond gets called after two years, the bond will be called at the par value, which is $1,000.  If John pays $1,100 for the bond and only gets $1,000 back at the call redemption, it means he would lose money, were it not for the $120 he received in coupon payments during those two years.  Thus, John came out ahead by $20 after two years in this situation.  By using a yield to worst calculator, we calculate that the yield to worst in this scenario is 0.93%.

Here is the scenario above broken down by the numbers.  You can see, the only thing that changes between the two is the time frame.

Yield To Maturity

Yield To Worst

So how can one quickly identify the risk for a bond with a yield to worst lower than the yield to maturity?  There are just two things to look for to know if you are at risk.

If the answer to either one of these questions is no, then you are not at risk of a lower yield to call than the yield to maturity.

If the answer to both of these is yes, then there is a third, more subjective question to be asked.

If market interest rates are trending upward, then the risk of a bond getting called is smaller than if market interest rates are trending downward.  Therefore, your chance of the bond getting called is less.

The yield to worst is the same calculation used to calculate yield to maturity.  It is an IRR or internal rate of return calculation.  We won't go into details on how IRR gets calculated, but from a high level, IRR measures all cash flows(both positive and negative) and uses those to calculate a rate of return.  To do your yield to worst calculation, you can use a yield to worst calculator, or just adjust the "years until maturity" to be the years until callable" on a YTM calculator.

Yield is the earning from our investments over a particular period, including all the interim cash flows. The dividends earned from stocks or the interests earned on debt instruments are considered for yield calculation. Yield is expressed as the percentage of the face value of the instrument or the current market value. It is a part of the total return, which considers all the cash flows from the investment.

Yield is calculated by dividing the net cash flow received by the amount invested or current value. It is calculated differently for stocks and bonds.

The yield is calculated in 2 ways, based on either the purchase amount or the current market price, whichever is easily available, as well as the dividend (i.e., the net cash flow):

The more common practice is to use the current yield as yield for stocks since it is based on the current market price and gives a more realistic picture.

For bonds and, in extension, debt mutual funds, yield is known as normal yield. Bonds usually trade at a premium (higher than original) or a discounted (lower than original) value.

Yield or Normal Yield of a Bond= Interest received in a year/ face value (original purchase price) of the bond or current price.

Similar to the yield calculation for stocks, yield for bonds can also be calculated if the bond’s purchase price or the current market price is provided. Since bonds are traded in the secondary market, their purchase price and current market prices differ. Bonds have a predefined rate of annual interest declared at the time of issuance, called Coupon. It is related to the market rate of interest determined by the Government at the time of issuance of the bond.

Below are the two yields commonly looked at when evaluating bonds-

For example, if an investor purchased a bond 5 years ago for Rs 1000, which gives an annual interest(coupon) of Rs 50, then his YOC = 50/1000100= 5%

The YOC and the coupon for bonds are the same and are calculated on the bond’s initial price, irrespective of the current market price.

Current Yield is the more commonly used concept as it is mapped to the bond’s current market price and not the purchase amount like YOC.

Let us take an example of a bond with purchase price of Rs 1000 and 5% coupon.

As shown in the table, the current yield changes with a change in the bond’s current market price. If the bond’s current market price falls, the current yield rises, and if it rises, the current yield rises. They are inversely proportional.

Now that you understand the yield meaning let us understand yield to maturity. Yield to maturity (YTM) is defined as the total return that you can expect from your investments in bonds, provided you hold the bond till its maturity and all the proceeds of the bond are reinvested in the same as well. Since stocks do not have a maturity date, this concept applies to bonds only.

Yield to Maturity = Total Interest Earned from the Bond over the years/ Face Value of the Bond

Bonds pay interest to the bondholders. So, if you need to evaluate and make an informed investment choice about which bond to purchase, you need to calculate the present value of all these future coupons. Yield to Maturity measures the current value of all future coupons of the bond by reinvesting all the coupon payments in the same bond. It is mostly expressed in annual terms.

There is a formula to calculate the approximate value of yield to maturity, which is-

Where:

Let us understand with an example by using the simple YTM formula. Assuming XYZ Ltd. issues bonds with a 5% annual coupon rate, face value Rs. 1000 and maturity 5 years.

In an ideal scenario with no change in bond price, the yield to maturity would also be 5%, i.e., the same as the coupon rate provided the bond is held till maturity.

Now, if the market rate of interest goes up to say 6%, this bond becomes less valuable, as investors would not find this investment (at coupon 5%) opportunity attractive. In such a case, the bond’s current market price would fall to, say, Rs 800. This would change the yield to maturity of the bond.

A bond investor would choose a bond based on the coupon, as he would like to hold it till maturity, in which case the YTM will be the same as the coupon rate. However, a bond trader would choose a bond based on the yield to maturity. A YTM calculator can help with these calculations.

Debt mutual funds have both Government and corporate bonds in them as underlying assets. These bonds pay interest periodically. For a debt mutual fund, YTM calculates the fund’s expected yield by taking the fund’s earning as a whole instead of a single bond. However, YTM is a good indicator for closed-ended funds and fixed-maturity plans as the portfolios are usually held till maturity. There is little scope of inflow and outflow of funds in the interim period.

However, for open-ended debt schemes, YTM may differ from the scheme’s actual returns, as there is constant inflow and outflow of money into the scheme that needs to be invested at the then-prevailing yield. Also, there could be a change in the fund’s portfolio based on the fund manager’s analysis and scheme’s objectives, i.e., the fund manager keeps buying and selling securities, because of which the YTM can change.

Here is an example of the Aditya Birla Sun Life Corporate Bond Fund, an open-ended scheme that has a YTM of 5.41%.

In the above table that represents a yield to maturity example, we see that the YTM of 5.41% for the fund (when calculated using its face value) increased to a maximum of 6.89% and fell to a minimum of 4.87% in that year. Yield to maturity changes due to the average price movement of all the bonds in the scheme. However, the category average of yield to maturity in similar funds is 5.27%, which means this fund has outperformed the category average.

Note: 1-year high and low depict the change in the number of bonds in the fund and the average maturity changes accordingly. This is because fund managers add and remove bonds from the fund as per the market scenario. So, the maximum number of bonds in the fund was 296 in a year, and the lowest was 192. Thus, the average maturity of the scheme also changed when the bonds were added and removed.

Though we use yield to maturity to compare bonds and debt mutual funds, this measure has certain limitations.

Primarily, yield to maturity helps to draw a comparison between bonds or debt mutual funds on the basis of their expected returns. It also helps investors to understand how changes in the market conditions, with the rise and fall of interest rates, affect their debt portfolio as well.

Yield to worst is a measure of the lowest possible yield that can be received on a bond that fully operates within the terms of its contract without defaulting. It is a type of yield that is referenced when a bond has provisions that would allow the issuer to close it out before it matures.