yield-to-call-and-yield-to-worst — yield duration and convexity

title: "Yield to Call and Yield to Worst" description: "Learn why yield to worst is your true planning yield for callable bonds, and how to avoid the costly mistake of chasing headline yields." slug: "yield-to-call-and-yield-to-worst" category: "Fixed Income" subcategory: "Yield Duration and Convexity" difficulty: "intermediate" readingTime: "5 min" author: "Equicurious" lastUpdated: "2025-12-29"

Investors regularly buy callable bonds showing 6% yields, only to receive 4% when the issuer calls the bond early. Research shows retail investors chasing the highest-yield bonds are significantly more prone to call-related losses (Barber & Odean, 2023). The practical antidote: always plan around yield to worst, not yield to maturity.

Why Callable Bonds Need Different Yield Measures (The Call Risk Reality)

When you buy a callable bond, you're selling the issuer an option. They have the right to redeem your bond early (usually when rates drop and they can refinance cheaper). This optionality means the yield you see quoted isn't necessarily the yield you'll receive.

Rates drop → Issuer exercises call → You get principal back early → Forced to reinvest at lower rates

The point is: callable bonds trading at a premium will almost certainly be called when rates fall. You're not going to earn that attractive yield-to-maturity because the issuer won't let you hold to maturity.

Three yield measures matter for callable bonds:

Yield to Maturity (YTM): The return if you hold until maturity and it's never called (often unrealistic for premium-priced callables)
Yield to Call (YTC): The return if the bond gets called at the first call date
Yield to Worst (YTW): The lowest yield among all call dates and maturity (your conservative planning number)

Calculating Yield to Call: A Worked Example

You buy a corporate bond with these terms:

Face value: $1,000
Coupon: 6% annual ($60 per year)
Current price: $1,050 (trading at a premium)
Years to maturity: 10 years
First call date: 3 years from now
Call price: $1,020

The yield to maturity assumes you hold for 10 years. At $1,050, the YTM is approximately 5.4%.

But the issuer can call in 3 years. The yield to call uses only 3 years of coupons ($180 total), the call price of $1,020, and your $1,050 purchase price. Running these numbers, the YTC is approximately 4.8%.

Why this matters: The difference between 5.4% YTM and 4.8% YTC is 60 basis points of return you might never see. If rates drop, the issuer will almost certainly call. You paid a $50 premium expecting 10 years of 6% coupons, but you'll only get 3 years.

The durable lesson: That 6% coupon looked attractive, but your actual yield may be closer to 4.8% if the call gets exercised.

Yield to Worst: Your True Planning Yield

Yield to worst compares the yield at every call date plus final maturity, then selects the lowest. This is the worst-case return for you (which is often the best-case for the issuer).

The test for when YTW matters most:

You're exposed to call risk if:

The bond trades above par (at a premium)
Interest rates have fallen since issuance
The call date is approaching
The bond's coupon significantly exceeds current market rates

When the bond trades below par (at a discount), the calculus reverses. The issuer won't call a discount bond (why pay more than market value to retire cheap debt?). In discount scenarios, YTC can exceed YTM, but YTW typically equals YTM since the call is unlikely.

The Reinvestment Trap

The real damage from early calls isn't just lower yield. It's reinvestment risk. When your callable bond gets redeemed, you receive principal precisely when rates are low (that's why the issuer called it). Now you must reinvest at those lower prevailing rates.

Rates drop → Bond called → Cash returned → Reinvest at lower rates → Double penalty

This is why research on retail bond investing matters: investors choosing the highest-yield bonds (often callables at premiums) systematically underperform. They're drawn to the headline yield without recognizing the reinvestment trap (the premium seems like "free money" until the call hits).

The practical point: When comparing callable and non-callable bonds, the callable should offer a yield premium to compensate for call risk. If a callable yields the same as a comparable non-callable, you're not being paid for the risk.

Detection Signals: When to Worry About Call Risk

You're exposed to call risk if:

Your callable bond trades 3%+ above par
Current market yields are 100+ bps below your bond's coupon
The first call date is within 2 years
The issuer has recently called other bonds in their capital structure

You're likely safe from call risk if:

Your bond trades at or below par
Current market yields exceed your bond's coupon
The call price exceeds the current market price

Connecting to Effective Duration and Negative Convexity

Callable bonds exhibit negative convexity near their call price:

When rates fall, price appreciation is capped (the call price acts as a ceiling)
When rates rise, the bond falls like any other bond
Duration shortens as rates fall (it behaves like a short-term bond when call becomes likely)

This is why effective duration (not modified duration) matters for callables. Effective duration accounts for how cash flows change when rates move. For a callable trading at a premium, effective duration might be 3 years even if modified duration suggests 7 years (Fabozzi & Mann, 2021).

For deeper analysis of embedded options and duration, see our coverage of effective duration for callable bonds. For the broader concept of negative convexity, see negative convexity and mortgage securities.

Essential Checklist for Callable Bonds

High ROI Actions:

Always quote YTW for callable bonds: Ignore YTM for planning purposes
Compare callables to non-callables on a YTW basis: A 5% YTW callable versus 4.8% non-callable might favor the non-callable after reinvestment risk
Check the call schedule: Calculate yield to each call date
Monitor holdings as rates fall: Rising call probability means effective duration is shortening

High-Impact Additions:

Calculate the yield differential: If YTW is 100-200 bps below YTM, call exercise is highly likely
Use effective duration: Modified duration overestimates price gains when rates fall because it ignores the call ceiling

The Bottom Line

What's the worst return you could receive? That's your yield to worst, and it should be your planning yield for any callable bond. The premium you paid and the high coupon you're receiving may disappear if the issuer exercises their call option (and they will, when it benefits them).

The durable lesson: Chasing headline yields without calculating YTW is one of the costliest mistakes in fixed income investing. Retail investors systematically fall into this trap, choosing bonds with attractive quoted yields that deliver disappointing actual returns.

Your Next Step

Pull up any callable bond in your portfolio. Calculate yield to worst, not just yield to maturity. If YTW is 100+ bps lower than YTM, that call option is valuable to the issuer (and you're probably not being adequately compensated for the risk).

Related Reading:

Nominal Yield, Current Yield, and Yield to Maturity - Understanding foundational yield measures
Effective Duration for Callable Bonds - Why standard duration fails for callable securities
Negative Convexity and Mortgage Securities - The same call-like dynamics in MBS

Yield to Call and Yield to Worst