Covered Bonds
February 12, 2025
In 1971, Richard Nixon single-handedly took the world off the gold standard. Ever since, many commentators have been of the opinion that the monetary system of the world will face a complete collapse. These fears get exaggerated every time there is a crisis. For instance, during the 2008 crisis, many people felt that the dollar […]
Start-ups connect with large corporations in many ways. The most common way for start-ups to connect with their larger counterparts is when they try to raise funds from these companies. It is common for start-up companies to approach bigger firms in order to pitch their business. However, a lot has changed in the start-up community […]
Markets across the world can also be segregated based on the type of intermediary. Prima facie, it may appear that the type of intermediary is not of much consequence. However, over time, market participants have realized that the type of intermediaries has a profound effect on the liquidity, efficiency as well as transaction costs related […]
America has been the hub of financial and entrepreneurial activity ever since the end of World War 2. However, over the past few years, the number of corporations that are using America as their base has been steadily declining. This is because of the unfavorable tax policies in America. America is the only country in […]
Today, the defined benefit pension plan is viewed as being a relic of the yesteryears. Most of the plans offered now are fixed contribution pension plans. However, a lot of retirees still have a fixed benefit pension plan. Also, it is important to understand how defined benefit pension plans work just for academic purposes. In […]
In the previous articles, we have studied the concept of yield to maturity. We now know how to calculate the yield on a particular bond. We also know why the calculation of this yield is important. However, it is important to realize that not all bonds are held until maturity. There is a large portion of bonds that are issued in the market which have callable features. This means that if the market interest rate reduces significantly, the issuer has an option to call their old bonds and then raise new bonds at a lower rate. The yield to maturity calculation becomes somewhat irrelevant for such bonds since they are unlikely to exist till maturity. Hence, it is common for investors to calculate yield to call and use that as a proxy for yield to maturity.
In this article, we will have a closer look at the concept of yield to call. We will also try to understand how it impacts the valuation of a bond.
The concept of yield to call is applicable only to the bonds which have a call feature. Theoretically, it is possible for bonds to be called at any time before their maturity. However, in real life, such bonds do not exist. It is common for callable bonds to have a schedule when these bonds can be called. For instance, it is possible for a bond to be called every five years. Hence, if the maturity is fifteen years, there is a possibility that the bond may be called either at five years or at ten years.
The concept of yield to call assumes that the bond will actually be called by the issuer at the earliest possible date. Hence, the yield i.e. the return provided by the bond is calculated based on such a scenario. Since the yield is calculated till the call date and not the maturity date, it is called yield to call.
Although, theoretically, investors are only supposed to calculate yield to call for the first call date. However, in reality, it is common for investors to calculate the yield to call for all possible call dates. These numbers are usually calculated beforehand and are taken into account while deciding whether or not to purchase the bond.
The calculation of yield to all is quite similar to the calculation of yield to maturity. Just like yield to maturity, yield to call is also made up of three parts.
Yield to call is important since it helps investors make several key decisions regarding a bond. Some of these important decisions have been listed below:
The bottom line is that yield to call is a very important metric for callable bonds. This is because yield to maturity becomes irrelevant in the case of such bonds. It is common for bond investors to systematically track this number and use it to make investment decisions.
Your email address will not be published. Required fields are marked *