What Is Yield To Call?

Yield to call (YTC) is a financial term that refers to the return a bondholder receives if the bond is held until the call date, which occurs sometime before it reaches maturity. This number can be mathematically calculated as the compound interest rate at which the present value of a bond's future coupon payments and call price is equal to the current market price of the bond.

Yield to call applies to callable bonds, which are debt instruments that let bond investors redeem the bonds—or the bond issuer to repurchase them—on what is known as the call date, at a price known as the call price. By definition, the call date of a bond chronologically occurs before the maturity date.

Generally speaking, bonds are callable over several years. They are normally called at a slight premium above their face value, though the exact call price is based on prevailing market rates.

Understanding Yield To Call

Many bonds are callable, especially municipal bonds and bonds issued by corporations. If interest rates fall, the company or municipality that issued the bond might opt to pay off the outstanding debt and get new financing at a lower cost.

Calculating the yield to call on such bonds is important because it reveals rate of return the investor will receive, assuming:

1. The bond is called on the earliest possible date
2. The bond is purchased at the current market price
3. The bond is held until the call date

Calculating Yield-To-Call

Although the formula used to calculate the yield to call looks slightly complicated at first glance, it is actually 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.

Yield-To-Call Example

As an example, consider a callable bond that has a face value of $1,000 and pays a semiannual coupon of 10%. The bond is currently priced at $1,175 and has the option to be called at $1,100 five years from now. Note that the remaining years until maturity does not matter for this calculation.

Using the above formula, the calculation would be set up as: $1,175 = ($100 / 2) x {(1- (1 + YTC / 2) ^ -2(5)) / (YTC / 2)} + ($1,100 / (1 + YTC / 2) ^ 2(5)) Through an iterative process, it can be determined that the yield to call on this bond is 7.43%.