Yield to Maturity vs. Yield to Call: What's the Difference?

Yield to Maturity vs. Yield to Call: An Overview

The buyer of a bond usually focuses on its yield to maturity (the total return that will be paid out by a bond's expiration date). But the buyer of a callable bond also wants to estimate its yield to call.

A callable bond can be redeemed by its issuer before it reaches its stated maturity date. Callable bonds usually offer a more attractive yield to maturity, along with the proviso that the issuer may "call" it if overall interest rates change and it finds it can borrow money less expensively in another way.

Therefore, two numbers are important to the investor considering callable bonds: Yield to maturity and yield to call. The date of a call, if there is one, is unknown up front, but it can be estimated.

Yield to Maturity

A bond's yield is the total return that the buyer will receive between the time the bond is purchased and the date the bond reaches its maturity. For example, a city might issue bonds that pay a yield of 2.192% per year until they mature on Sept. 1, 2032.

A calculation of yield to maturity assumes that all interest payments are received from the date of purchase until the bond reaches maturity and that each payment is reinvested at the same rate as the original bond. (An investor can also determine the market value of a bond by checking the spot rate, as this metric takes fluctuating interest rates into account.)

Yield to maturity is based on the coupon rate, face value, purchase price, and years until maturity, calculated as:

Yield to maturity = {Coupon rate + (Face value – Purchase price/years until maturity)} / {Face value + Purchase price/2}

Yield to Call

An investor in a callable bond also wants to estimate the yield to call, or the total return that will be received if the bond purchased is held only until its call date instead of full maturity.

A callable bond is sold with the proviso that the issuer might pay it off before it reaches maturity. If interest rates fall, the company or municipality that issued the bond might opt to pay off the outstanding debt and get new financing at a lower cost.

The price paid by the investor will be higher than the face value of the bond. Generally, the earlier a bond is called, the better the return for the investor.

Most municipal bonds and some corporate bonds are callable. Treasury bonds are not, with a few exceptions.

Callable bonds are issued with one or more call dates attached. The price paid will be above the face value of the bond, but the exact price will be based on prevailing rates at the time.

The yield to call can be estimated based on the bond’s coupon rate, the time until the first or second call date, and the market price.