Bond yields can be complicated enough, not to mention the difference between Yield to Maturity, or YTM and Yield to Call, or YTC. But, even if you understand it all, which one do you use?
Higher Bond Yields Are Better
It doesn’t take an investing genius to know that higher bond yields are better than lower bond yields. But, what if there are two yields to choose from?
Some bonds have a call feature. This feature is designed to give the issuer more control over its debt. A call feature gives the issuer the right to redeem, or call, the bonds at a certain price at a certain date in the future as specified in the initial bond offering.
Usually, the call feature requires the bond issuer to pay a premium to the original face value of the bond as compensation to the investor for redeeming the bond early. However, there is no obligation on the part of the issuer to call the bond. Therefore, the issuer has all of the control regarding triggering the call feature and is thus likely to do so only if it is advantageous to the company instead of the investor.
Yield to Maturity or Yield to Call
Since it can be assumed that the bond issuer will call the bond if it is in the issuer’s own best interest, it follows that the investor is likely to receive the YTC only if calling the bond would result in a lower cost to the issuer, and thus a lower yield to the investor.
Likewise, since it can be assumed that the issuer will not call the bond if it would cost more to redeem the bonds than to leave them in force, then it also follows that the investor can expect to receive the YTM only if that option would result in a lower yield.
When It Comes to YTC or TYM Use the Lowest Yield
Because the investor can expect the bond issuer to take whichever course of action would end up producing the lowest yield to the investor, bond yields are always quoted to the lower of the Yield to Call or the Yield to Maturity.
However, it is important for the skilled and savvy bond investor to always know both yields before buying a good bond investment.