There are four different ways to quote a yield. While we commonly use yield to maturity and running yield, where a bond has a call date, that is can be repaid early, investors need to be aware of yield to call and yield to worst
There are four different ways to quote a yield. While we commonly use yield to maturity and running yield, where a bond has a call date, that is can be repaid early, investors need to be aware of yield to call and yield to worst.
A couple of weeks ago we published a note on running yield and yield to maturity in a note called “Understanding bond yields – a piece of cake”. This week we add ‘yield to call’ and ‘yield to worst’ to help you work out which best suits your objectives. We use the Capitol Health bond to demonstrate the various yields that may be quoted.
Yield to call
Many bonds are callable at the option of the company before the final maturity date. That is, the bonds can be repaid early, prior to maturity. For example, subordinated bonds issued by banks and other financial institutions since 1 January 2013, all have call dates, which may be five, ten, twenty or more years until final maturity.
The company has the option to repay at the call date. With some bonds, the call dates continue after the first call date and are every interest payment date thereafter until maturity. With others, there may be only an annual opportunity for example.
If a particular bond’s price rises to be above par and is at a premium, then the chances of an early call will increase. Theoretically, the company can issue new bonds at a lower rate.
Investors trying to work out the possible returns on callable bonds need to assess the yield to call and the yield to maturity to get a sense of what is possible. The problem with “yield to call” as a measure is that it is actually the yield to first call, but the yield to the second or subsequent call might be worse.
Yield to worst
Yield to worst tells you what your yield would be in the worst case scenario for you, if the company decides to call your bond at the worst possible time or if it chooses not to call your bond and that means you get a lower yield than if they had called it.
Yield to worst could be the same as yield to call if the first call is the worst outcome for you; it could be the same as yield to maturity if you are worst off when the company chooses not to call at all; or it could be lower than both of them where you are worst off if the company calls on the second or subsequent call date.
Capitol Health
Established in 2001, Capitol Health is a large Australian medical diagnostic imaging business. It is ASX listed and employs over 700 staff and contractors across approximately 70 facilities in Victoria and NSW.
The bonds were issued by Capitol Treasury, a wholly owned subsidiary of Capitol Health. The four year, fixed rate bonds were issued with a coupon of 8.25% per annum. They contain a series of call options starting two years after the issue date and then occurring every six months.
Current yields are as follows:
Capitol Health Treasury yields
| Type of yield | Percent per annum |
| Yield to call | 7.35% |
| Yield to worst | 6.89% |
| Yield to maturity | 6.97% |
| Running yield | 7.93% |
Source: FIIG Securities
Note: Prices accurate as at 4 October 2016 but subject to change
The best possible outcome for an investor purchasing the Capitol Health bond on 4 October 2016 is that the company calls the bond early. The yield to call of 7.35% per annum is the highest possible return available. The worst return is 6.89% per annum, 0.46% lower than yield to call.
Glossary
Coupon
Is the rate of interest paid on a bond. Coupons can be paid annually, semi-annually or quarterly or as agreed in the terms of the security. The coupon rate can be fixed or floating for the term of the security. If it is a floating rate then it is likely that it will be linked to a benchmark such as the 90 day bank bill rate.
The coupon rate is set by the issuer based on a number of factors including prevailing market interest rates and its credit rating. Fixed rate bonds in Australia predominantly pay a semi-annual coupon whereas floating rate bonds predominantly pay a quarterly coupon. Indexed linked bonds usually pay quarterly coupons.
For example, a $500,000 bond with a fixed rate semi-annual coupon of 8% will pay two $20,000 coupons each year.
Running yield
Running yield uses the current price of a bond instead of its face value and represents the return an investor would expect if he or she purchased a bond and held it for a year.
It is calculated by dividing the coupon by the market price.
Yield to maturity
The return an investor will receive if they buy a bond and hold the bond to maturity.
It is the annualised return based on all coupon payments plus the face value or the market price if it was purchased on a secondary market. Yield to maturity thus includes any gain or loss if the security was purchased at a discount (below face value) or premium (above face value).
It refers to the interest received from a security, and is usually expressed annually or semi annually as a percentage based on the investment’s cost, its current market value or its face value.
Bond yields may be quoted either as an absolute rate or as a margin to the interest rate swap rate for the same maturity. It is a useful indicator of value because it allows for direct comparison between different types of securities with various maturities and credit risk. Note that the calculation makes the assumption that all coupon payments can be reinvested at the yield to maturity rate. Not to be confused with the coupon, which is the actual interest cashflow received during the life of the investment.