Yield To Call

To contact us Click HERE
Most Municipal Bonds are callable because municipalities normally need to manage their interest rate risk more carefully to handle public Government cash flow and possible short falls.

If a bond is callable, it is very important to be aware of the yield to call. If the investment is called early at a lower price than what you paid, your YTC will be lower. If the call price is higher, then yield is higher.
Usually it is best for call dates to be as far out as possible for an investor. Normally a called bond is an unwanted occurance for an investor. Bonds are usually called when interest rates decline, so an investor will be forced to invest the proceeds elsewhere at lower rates.

Callable bonds are priced to the call date or the maturity date. Bond brokers will price the bond to the call when it's a premium, and price to the yield to maturity when it is a discount bond.

Premium and Discount Bonds

The reason for pricing these bonds differently is twofold. A bond is priced at a premium because the Nominal Yield or coupon rate is higher than current interest rates. Since bonds with higher nominal yields will get called first, it makes sense to price the to the call (ytc). It is also the worse case for the investor. If the bond is called early, the investor will lose the premium faster than if it went to maturity. The yield will be lower if the investment is finished early.

Discount bonds will have a higher yield if they were called early vs. pricing them to maturity. They are not priced to the call normally. Discount debt has a lower nominal yield than the market, so they are less likely to see a call date acted on. Discount bonds are priced to a Yield To Maturity.

Book Recommendation: The Handbook of Fixed Income Securities