Yield to Worst (YTW)
What it is:
How it works/Example:
The concept is best illustrated with an example.
Let's assume you own a callable bond issued by Company XYZ. The bond has a coupon rate of 5%, $1,000 par value, and maturity of three years. The bond is currently priced at $1,012 and makes an annual coupon payment. It is callable in 1 year.
We can use this information to calculate the bond's yield to maturity (YTM). By plugging the numbers into the InvestingAnswers' Yield to Maturity Calculator, we see that the yield to maturity is 4.56%.
However, we have to remember that the bond is callable in just one year from today. If the bond is called, you will get your money back, but you'll miss out on two years of interest payments. We need to calculate the yield to call (YTC). Using the Yield to Call (YTC) Calculator, we see that the yield to call is only 3.75%.
Therefore, our worst-case scenario is that the company will call the bond in one year, and we'll realize a yield of 3.75% instead of 4.56%. The yield to worst is 3.75%.
Why it matters:
Callable bonds tend to be good for the company, but bad for the investor. If interest rates decline, the company will probably choose to call their bonds and refinance them at a lower rate, leaving the investor to find a new place to invest.
Thus, the yield to worst calculation is very important to investors who want to know the minimum yield they can expect to receive from their bond investments. As illustrated above, yield to worst is simply the lowest of yield to maturity or yield to call. It is never higher than yield to maturity.