Lesson 3 of 5 · 14 min
Callable bonds: yield-to-call, yield-to-worst and option-adjusted yield
A callable bond may not live to maturity, so investors compute a yield to every possible call date and take the lowest one, or value the call option and strip it out.
In short
- A callable bond lets the issuer buy it back at set call prices on set dates, after a call protection period.
- Yield-to-call: the YTM formula with N = periods to a call date and the call price in place of par.
- Yield-to-worst (YTW) = the lowest of all yields-to-call and the YTM: the most conservative return estimate.
- The lowest yield is not always the first call: it depends on the price and the call price schedule.
- Call option value = option-free bond price − callable bond price. The call option hurts the investor, so the callable bond is cheaper.
- The option-adjusted yield is the yield computed from the option-adjusted price (flat price + value of the call).
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