There can be four different yields mentioned when referring to bonds and fixed income products and it’s important to understand the distinction between them. The first three refer to the yield if you hold the security until maturity. The fourth, running yield is the income you could expect to earn if you hold the security for the next 12 months:
- Yield to Maturity (YTM)
- Yield to Call (YTC)
- Yield to Worst (YTW)
- Running Yield
Yield to maturity (YTM) is the most common referenced fixed income return. Simply, it measures the expected return on an investment if bought and held to maturity. If a bond is bought in the secondary market, then it includes the coupon payments plus the market price in the calculation.
The YTM assumes the distributions are reinvested at the same rate.
YTM allows you to compare bonds with different maturity dates as well as similar rated bonds and funds to help determine which offers better relative value.
The problem with YTM is when bonds have multiple possible maturity dates, prior to final maturity.
Yield to call (YTC) is typically used for subordinated bonds and corporate hybrids where there is a call date prior to final maturity. In Australia, a typical yield to call term might be 10NC5, or 10 years until maturity but callable, or repayable after five years. Investors would expect the bond to be called at five years, the first opportunity, but this isn’t always the case. In rare circumstances, call dates have been missed.
Recent issuance has seen extended terms such as 15NC10 and some corporate hybrids have had much longer terms until final maturity, with significant penalties if the call date is missed.
Yield to worst (YTW) is the worst possible time for an investor to be repaid if a bond is called early. The yield is typically lower than the yield to maturity.
It’s important to understand the possibility of earning lower than expected returns when comparing a range of securities for investment. YTW helps investors determine whether investments are good relative value.
Running Yield is the annual income on an investment divided by its current price, so differs from the coupon.
A Coupon is the interest rate paid on a fixed income investment or bond. Coupons can be fixed, floating or inflation linked and some start as fixed then, at a later date, convert to floating. Coupons can be expressed as an absolute rate or as a margin above a benchmark, such as the Bank Bill Swap Rate (BBSW).
Which Yield is Best?
The best yield is the most appropriate for the type of bond. If the bond has a bullet repayment, that is where the security is structured in such a way that it is repaid in full, with one payment at the end of the term, then YTM is best.
If there is a single call date, then YTC or YTW are both appropriate.
YTW is the best measure if there are multiple possible call dates.
