Estimate the annual rate of return for a callable bond, assuming it is held until its first or next call date.
Yield to Call (YTC):
7%
Total Coupon Payments until Call:
250
Capital Gain/Loss at Call:
100
Total Cash Flow:
1300
Yield to Call (YTC) is the iterative rate that equates the present value of a bond's future coupon payments and its call price to its current market price.
Formula: P = [Σ (C / (1 + r)^t)] + [CP / (1 + r)^n] where P is price, C is coupon, CP is call price, and r is YTC.
P = [Σ (C / (1 + r)^t)] + [CP / (1 + r)^n]
Consider a $1,000 par bond trading at $1,050 with a 6% coupon, callable in 5 years at $1,030.
Yield to Maturity (YTM) assumes the bond is held until the end of its life, while YTC assumes the issuer redeems it at the earliest possible call date.
Issuers typically call bonds when interest rates drop, allowing them to refinance their debt at a lower cost, similar to refinancing a mortgage.
YTC is most important for bonds trading at a premium, as they are the most likely candidates to be called by the issuer.
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