Same Bond, Two Possible End Dates

Yield to maturity is the annual return an investor earns if a bond is bought at today’s price and held until it matures, with all payments made on time. Yield to call is the annual return earned if the issuer redeems the bond early on its first call date, at the call price.

For a callable bond trading at a premium, yield to call is lower than yield to maturity, because the investor loses the premium over a shorter period. For a callable bond trading at a discount, yield to call is higher, because the investor gains the discount sooner.

Brokers must quote the lower of the two, known as yield to worst, so investors are not misled about the return they can count on. For the full route from the exam to a career explaining these yields to clients, our complete guide to how to become an investment adviser representative covers every step.

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How Yield to Maturity Works

Yield to maturity is the discount rate that makes the present value of all a bond’s remaining coupons and its face value equal to its current price. It captures both the income from the coupons and any gain or loss from buying above or below face value.

It assumes the bond is held to maturity, every payment is made on time and coupons are reinvested at the same yield. Those assumptions rarely hold perfectly, but yield to maturity is still the standard way to compare bonds with different coupons, prices and maturities.

Yield to maturity moves in the opposite direction to price. The Series 65 Exam Preparation course at FRC covers every bond yield measure the exam tests, including the order in which they rank for premium and discount bonds.

How Yield to Call Works

Yield to call uses the same calculation, but it replaces the maturity date with the first call date and the face value with the call price. It answers the question: what will I earn if the issuer redeems this bond at the first opportunity?

Issuers usually call bonds when interest rates have fallen, so they can refinance at a lower cost. That means a bond trading well above face value, which reflects rates having fallen since issue, is more likely to be called.

Some bonds have several call dates, sometimes with call prices that step down over time. In that case, a yield can be calculated to each call date, and the lowest is the one that matters most.

Yield to Worst: The Number Brokers Must Quote

Yield to worst is the lowest of the yield to maturity and the yields to each possible call date. It is the minimum return an investor can expect, assuming the issuer makes every payment.

Under MSRB and FINRA rules, confirmations for callable bonds must show the lower of yield to call and yield to maturity. That stops a broker from advertising a premium bond’s yield to maturity when the bond is likely to be called and earn less.

For a premium callable bond, yield to worst is usually the yield to call. For a discount callable bond, it is usually the yield to maturity, because an early call at par would actually raise the investor’s return.

Yield Measures Compared for Premium and Discount Bonds

Worked Example: A Premium Bond

A bond pays a 6 percent annual coupon, or $60 a year, matures in ten years and is callable at $1,000 in five years. It trades at $1,080.

Step one: the nominal yield is 6 percent, and the current yield is $60 divided by $1,080, or about 5.56 percent. Step two: the yield to maturity, which spreads the $80 premium loss over ten years, is about 4.97 percent.

Step three: the yield to call, which spreads the same $80 loss over only five years, is about 4.19 percent. The ranking runs nominal, current, maturity, call, from highest to lowest, and the yield to worst is the 4.19 percent yield to call.

Worked Example: A Discount Bond

The same type of bond trades at $920 instead. Step one: the current yield is $60 divided by $920, or about 6.52 percent, above the 6 percent nominal yield.

Step two: the yield to maturity, which spreads the $80 gain over ten years, is about 7.15 percent. Step three: the yield to call, which collects the same $80 gain in five years, is about 8.00 percent.

The ranking is reversed: nominal, current, maturity, call, from lowest to highest. The yield to worst is now the 7.15 percent yield to maturity, because an early call would only improve the investor’s return.

Study Bond Yields With FRC

Bond yield questions are among the most predictable on the exam, and the ranking of yields for premium and discount bonds appears again and again. Our Series 65 course teaches the ranking alongside the calculations, so you can answer quickly and accurately.

Consider studying with FRC for every exam on your route. Explore our USA exam courses, from the SIE through the Series 7, Series 63 and Series 65.

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A Quick Approximation for the Exam

Calculating an exact yield requires trial and error or a financial calculator. A widely used approximation divides the annual coupon, adjusted for the gain or loss per year, by the average of the face value and the price.

Worked example: for the premium bond, the approximate yield to maturity is $60 minus $80 divided by 10, which is $52, divided by the average of $1,000 and $1,080, which is $1,040, giving 5.0 percent. Step two: the approximate yield to call is $60 minus $80 divided by 5, which is $44, divided by $1,040, giving about 4.23 percent.

Both estimates are close to the exact answers of 4.97 and 4.19 percent. On the exam, recognising which yield is higher or lower usually matters more than calculating either one precisely.

The Effect of a Call Premium

Some bonds are callable at a price above face value, such as $1,020, which compensates investors for losing the bond early. A call premium raises the yield to call, because the investor receives more when the bond is redeemed.

Worked example: if the premium bond above were callable at $1,020 instead of $1,000, the investor would lose only $60 rather than $80 over the five years to the call date. Step one: the yield to call rises from about 4.19 percent to about 4.54 percent. Step two: it is still below the 4.97 percent yield to maturity, so yield to worst is still the yield to call.

Call premiums often decline over time, for example from $1,030 in the first call year to $1,000 a few years later. Each call date can then produce a different yield, and yield to worst picks the lowest.

Yield to Put

Some bonds give the investor, rather than the issuer, the right to end the bond early. A putable bond lets the holder sell it back to the issuer at a set price on certain dates, usually at face value.

Yield to put is calculated in the same way as yield to call, using the put date and put price. Because the put protects the investor if rates rise or the issuer’s credit weakens, putable bonds usually offer lower yields than similar bonds without a put.

The put works in the investor’s favour, while a call works in the issuer’s favour. That is why a call feature raises a bond’s yield and a put feature lowers it.

How Price Changes Move Each Yield

Every yield measure except nominal yield moves in the opposite direction to the bond’s price. When the price rises, current yield, yield to maturity and yield to call all fall; when the price falls, they all rise.

Worked example: the 6 percent bond in the earlier examples moves from $1,080 to $920, a swing from a premium to a discount. Step one: its current yield rises from about 5.56 percent to about 6.52 percent. Step two: its yield to maturity rises from about 4.97 percent to about 7.15 percent, and its yield to call jumps from about 4.19 percent to about 8.00 percent.

Yield to call moves the most, because the gain or loss relative to the call price is spread over the shortest period. This is one reason callable bonds can feel unpredictable to investors who focus only on the coupon.

Municipal Bonds and Yield to Worst

Callable bonds are especially common in the municipal market, where many long-term bonds can be called after about ten years. Municipal bonds are also often issued at a premium, which makes yield to worst particularly important for municipal investors.

MSRB rules require dealers to disclose yield to worst on municipal trade confirmations and to price callable municipal bonds to the lower of the call and maturity yields. Investors comparing municipal bonds should therefore focus on yield to worst rather than the coupon or yield to maturity alone.

What Makes a Call More Likely

The main driver is interest rates. If market rates fall well below the bond’s coupon, the issuer can save money by calling the bond and issuing new debt at a lower rate.

An improvement in the issuer’s credit rating can also make a call attractive, because the issuer can now borrow more cheaply. Conversely, if the issuer’s credit weakens, refinancing becomes harder and a call is less likely, as covered in our article on what happens when a bond is downgraded.

Call protection, the period before the first call date, gives investors some certainty. Our comparison of callable vs non-callable bonds explains how call protection and call risk affect pricing.

Using Yields in Client Advice

For income-focused clients, yield to worst is the safer figure to plan around. Using a premium bond’s yield to maturity could overstate the income a client will actually receive if the bond is called.

Advisers should also consider reinvestment risk. When a bond is called after rates have fallen, the client must reinvest the proceeds at lower rates, so the true long-term return can be lower than either quoted yield.

Comparing yield to worst across bonds with similar credit quality and maturity helps clients see which offers better value. It also shows when a higher-coupon callable bond is less attractive than it first appears.

The Memory Aid

Remember “premium: call is smallest; discount: call is biggest”: for a premium bond, yield to call is the lowest yield, and for a discount bond it is the highest.

For the ranking, remember “nominal, current, maturity, call”, which runs from highest to lowest for a premium bond and from lowest to highest for a discount bond.

For quotes, remember “worst is what you’re told”: brokers must show yield to worst, the lower of the call and maturity yields.

Exam Traps to Avoid

The first trap is assuming yield to call is always lower than yield to maturity. That is true only for premium bonds; for discount bonds it is higher.

The second trap is confusing current yield with yield to maturity. Current yield ignores the gain or loss at maturity, while yield to maturity includes it.

The third trap is forgetting that a call premium raises yield to call. The fourth trap is quoting a premium callable bond’s yield to maturity to a client; the lower yield to call is the relevant figure.

A Client Scenario

A retired client wants income and is choosing between two A-rated bonds. Bond one pays a 6.5 percent coupon, trades at $1,090 and is callable at par in two years, with a yield to maturity of 5.2 percent; bond two pays 5 percent, trades at $1,005 and is non-callable, with a yield to maturity of 4.9 percent.

The adviser explains that bond one’s yield to call is much lower than its yield to maturity, because the $90 premium would be lost over just two years if the bond were called. Its yield to call, and therefore its yield to worst, is only about 1.9 percent, far below bond two’s 4.9 percent yield.

The adviser also explains that if bond one is called, the client would have to reinvest at whatever rates are then available. The client chooses bond two for its more predictable income, and the adviser documents the comparison and how it fits her income needs.

The Dictionary as a Video Library

The FRC dictionary is a study tool, not just a glossary. Every entry pairs a written explanation with deep-dive video, on-page quizzes and interactive flash cards, so you can read a concept, watch it explained and test yourself in one place.

Rules are covered in the same depth: open a rule and you will find the full explanation alongside video walk-throughs of how it applies in practice. Open the yield to maturity, yield to call and yield to worst entries to see each calculation worked through on video.

Practice Questions to Test Yourself

Question one: A callable bond trades at a premium. Which is lower, its yield to call or its yield to maturity? Its yield to call.

Question two: For a bond trading at a discount, rank the nominal yield, current yield, yield to maturity and yield to call from lowest to highest. Nominal yield, current yield, yield to maturity, yield to call.

Question three: Which yield must a broker show on the confirmation for a callable bond? The lower of yield to call and yield to maturity, known as yield to worst.

Question four: A bond pays $50 a year and trades at $1,000. What is its current yield? 5 percent.

Question five: What usually makes an issuer call a bond? A fall in interest rates, which lets the issuer refinance more cheaply.

Turn Fixed Income Knowledge Into Career Evidence

Bond yields are one of the first things clients ask about when building an income portfolio, and advisers who explain them clearly build trust quickly. FRC’s Digital Profile shows employers the courses you are actively studying and the progress you have earned through assessed learning, verified by FRC, and a QR code on your resume takes them straight to it.

The FRC Video Resume lets a hiring manager hear you before the interview. Walking through why a high-coupon callable bond can yield less than it seems shows the analytical care that fixed income roles demand.

Related Questions

Many agency bonds are callable while Treasuries generally are not, which is one reason their yields differ, as explained in Agency Bonds vs Treasury Bonds.

Key Points to Retain

Yield to maturity measures the return if a bond is held to its final maturity date, while yield to call measures the return if it is redeemed at the first call date and call price. For premium bonds, yield to call is lower than yield to maturity; for discount bonds, it is higher.

Yield to worst is the lowest of the possible yields, and brokers must quote it on callable bond confirmations. Call premiums raise yield to call, falling interest rates make calls more likely, and income-focused clients should plan around yield to worst.

For the role the exam leads to, read our guide to what an investment advisor representative is.