Yield to worst
Capital MarketsThe lowest yield a bond can produce across its scheduled redemption dates, and the honest number whenever the issuer holds the option.
Also written: YTW, yield to call
A callable bond can be redeemed early, at dates and prices written into the documents. Each of those dates produces its own yield, computed exactly like a yield to maturity but ending at the call date and the call price rather than at maturity and par. Yield to worst is the lowest of all of them, the yield to maturity included.
It is the right number because of who holds the option. The issuer decides whether to call, and it will call when refinancing costs less than the coupon it is paying, which is when rates or its own credit spread have fallen. That is precisely the state of the world in which the holder would rather keep the bond. An option written against you is not an option you own, and a yield you can only earn if the other side declines to exercise is not a return to underwrite.
How far the two yields diverge depends on where the price sits relative to the call price and how near the call date is. A bond a little above its call price with the call two years away shows a gap of a few basis points. A high yield bond trading well above a call price that comes into effect next quarter can show yields points apart, and quoting the yield to maturity there is close to fiction.
The mirror case matters for the issuer's own cost of debt. Part of a callable bond's coupon is what the issuer paid for the option, so neither of its yields is a clean read of what the company would pay for straight money today. For a WACC, prefer a liquid non callable bond of matching seniority and maturity, or a genuine new issue level.
Worked example
Illustrative. A five year bond with a 9% coupon trades at 107 and is callable in two years at 104.
Held to maturity it yields about 7.28%. Redeemed in two years at 104 it yields about 7.06%, because the holder pays 107 now and receives 104 then. The yield to worst is 7.06%.
The issuer's incentive confirms it. With yields unchanged the bond would be worth about 105.4 at the call date with three years left to run, so redeeming at 104 and refinancing is the cheaper course, and the holder gets the lower of the two yields.