What is your yield if the issuer can hand the money back early?
Many corporate and municipal bonds are callable: the issuer has the right, not the obligation, to redeem the bond early at a set price on set dates. That option belongs to the borrower — and it changes what "yield" means.
Why issuers call
An issuer calls when refinancing is cheaper than paying you. Rates fall, the issuer redeems your 5% bond and issues a new one at 3%. Rational for them, inconvenient for you: your high-coupon bond disappears exactly when replacements are scarce.
Yield to call is the same arithmetic, shorter
Yield to call (YTC) is solved exactly like YTM, except the cash flows stop at the call date and the final payment is the call price, not par.
Take a bond with a 5% coupon, 10 years to maturity, callable in 3 years at €1,020, currently trading at €1,060:
- Current yield = 50 ÷ 1,060 = 4.72%
- Yield to maturity (10 years, redeemed at €1,000) ≈ 4.25%
- Yield to call (3 years, redeemed at €1,020) ≈ 3.50%
Check the YTC by hand: 50 ÷ 1.035 + 50 ÷ 1.035² + 1,070 ÷ 1.035³ = 48.31 + 46.68 + 965.08 = €1,060. That's the price, so 3.50% is the rate.
Three legitimate "yields" on one bond, spanning 122 basis points. Anyone quoting just one of them is choosing a story.
Two kinds of call
Not every call is the fixed-price call above. Most US investment-grade bonds carry a make-whole call: the redemption price is the present value of the remaining payments discounted at the Treasury yield plus a small margin, often 10 to 30 basis points, so the strike rises as rates fall and the issuer gains almost nothing by exercising. Make-whole bonds are priced to maturity, and their yield to worst is their yield to maturity. The fixed-price call that produces a lower yield to worst and negative convexity is the high-yield pattern: no call for three to five years, then callable at par plus half the coupon, stepping down to par. Read which one the prospectus contains first.
Yield to worst
With several call dates, you compute the yield to each of them plus the yield to maturity, and take the lowest. That is the yield to worst — here, 3.50%.
The convention exists because the option is the issuer's, and a prudent analyst prices the scenario in which the counterparty uses their option in the way least convenient to you. It is a conservatism convention, not a forecast: nobody is claiming the bond will be called.
The asymmetry you are being paid for
Look at what the call does to your two outcomes:
- Rates fall → the bond is called → you get €1,020 back and must reinvest at the new, lower rates. Your upside is capped near the call price.
- Rates rise → the bond is not called → you are left holding a long, low-coupon bond that has fallen in price. Nothing caps that fall the way the call price caps your gain — the payoff is asymmetric, and the asymmetry is against you.
Capped upside, uncapped downside. That is why callable bonds must offer a higher yield than an otherwise identical non-callable bond — the extra yield is the premium you receive for having sold the issuer an option. Puttable bonds mirror the arrangement: you hold the option, so they yield less.
This asymmetry also breaks the clean duration formulas you're about to learn, which is why callables are measured with effective duration and can show negative convexity. Unit 3 comes back to it.
Try it now
- Start with where the terms live. A market curve, like the high-quality corporate curve below, is a yield per maturity built from many issuers, with no issuer, no coupon and no call date anywhere in it. One bond's first call date and call price come from its prospectus. Here are the terms as a prospectus would state them for an illustrative bond: 6% annual coupon, €1,000 face, 8 years to maturity, first callable in 2 years at €1,030, trading at €1,080.
- Compute its current yield, its yield to that first call and its yield to maturity (a trial-and-error solver or the approximation formula from the YTM lesson will do). Which is lowest, and does the bond trade above or below its call price? (Current yield 5.56%, yield to maturity about 4.77%, yield to call about 3.28%.)
- In one sentence, say why a careful analyst quotes yield to worst, and why that is a convention rather than a prediction about the issuer's behaviour.