The yield to worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting. The YTW is calculated by making worst-case scenario assumptions on the issue by calculating the return that would be received if the issuer uses provisions, including prepayments, calls or sinking funds. This metric is used to evaluate the worst-case scenario for yield to help investors manage risks and ensure that specific income requirements will still be met even in the worst scenarios.

1:28 Yield to Worst BREAKING DOWN Yield To Worst - YTW

A bond& YTW is calculated on all possible call dates. It is assumed that a prepayment occurs if the bond has a call option and the issuer can offer a lower coupon rate based on current market rates. The YTW is the lowest of yield to maturity or yield to call (if the bond has prepayment provisions); YTW may be the same as yield to maturity, but it can never be higher. It is the holder& lowest rate of return.

The Mechanics

The yield to call is the annual rate of return assuming the bond is redeemed by the issuer on the next call date. A bond is callable if the issuer has the right to redeem it prior to the maturity date. YTW is the lower of the yield to call or yield to maturity. A put provision gives the holder the right to sell the bond back to the company at a certain price at a specified date. There is a yield to put, but this doesn& factor into the YTW because it is the investor& option on whether to sell the bond.

Determining Which Yield is Right

If a bond is not callable, the yield to maturity is the appropriate yield for investors to use because there isn& a yield to call. However, if a bond is callable, it becomes important to look at the YTW. In particular, for a bond is trading above par value, the yield to maturity may be higher than the yield to call because the investor pays a premium that takes away from the return. In this case, the YTW is important to examine since the bond could be called and this is the lowest yield possible, assuming there is not a default.

If a bond is trading below par, the discount adds to an investor& return. Therefore, the yield to maturity is lower than the yield to call, even if the security can be redeemed. The yield to maturity is the YTW.

Both yield to maturity and yield to call are estimates of return. The yield to call and yield to maturity both assume the coupons are reinvested at the lower rate, but interest rates change. It also assumes the bond is held until the call date or maturity.