Understanding Yield to Call

While most investors evaluate bonds based on yield to maturity, callable bonds introduce an additional wrinkle: the issuer can redeem the bond at a predetermined price before maturity. Yield to call (YTC) measures the annual return assuming the bond is called on that earliest date. This metric helps investors compare callable bonds to non-callable alternatives and assess reinvestment risk.

Calculation Method

YTC solves for the discount rate that equates the present value of future coupon payments and the call price with the bond’s current market price. Because no simple algebraic solution exists, the calculator uses an iterative approach. It repeatedly guesses a yield value, discounts each coupon and the call price, and adjusts the guess until the present value matches the bond’s price.

Example

Suppose a bond sells for $980 with a 4% annual coupon, callable in five years at $1,020. The iterative formula finds a yield to call of roughly 4.5% per year. If interest rates fall, the issuer may redeem the bond at that time, forcing investors to reinvest at potentially lower rates.

Limitations

Yield to call assumes the bond will indeed be called on the first possible date, which may not occur. Some issuers let callable bonds remain outstanding if rates are higher than the coupon. Consider yield to worst, comparing YTC with yield to maturity, to understand the full risk profile.