Yield to Worst (YTW): What It Is and the Formula to Calculate It

What Is Yield to Worst (YTW)?

Yield to worst is a measure of the lowest possible yield that can be received on a bond that fully operates within the terms of its contract without defaulting. It is a type of yield that is referenced when a bond has provisions that would allow the issuer to close it out before it matures. Early retirement of the bond could be forced through a few different provisions detailed in the bond’s contract—most commonly callability.

The yield to worst metric is used to evaluate the worst-case scenario for yield at the earliest allowable retirement date. YTW helps investors manage risks and ensure that specific income requirements will still be met even in the worst scenarios.

Understanding Yield to Worst

A bond's YTW is calculated based on the earliest call or retirement date. It is assumed that a prepayment of principal occurs if a bond issuer uses the call option. After the call, principal is usually returned and coupon payments are stopped. An issuer will likely exercise their callable option if yields are falling and the issuer can obtain a lower coupon rate through new issuance in the current market environment.

The YTW may also be known as the yield to call (YTC). In order to identify the YTW, yield to call and yield to maturity should both be calculated. In general, YTW may be the same as yield to maturity, but it can never be higher since it represents yield for the investor at an earlier prepayment date than the full maturity. YTW is the lowest possible return an investor can achieve from holding a particular bond that fully operates within its contract without defaulting. YTW is not associated with defaults, which are different scenarios altogether.

The Mechanics

The yield to call is an annual rate of return, assuming a bond is redeemed by the issuer at the earliest allowable callable 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 investor 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't factor into the YTW because it is the investor's option on whether to sell the bond. Bond investors will also review similar-duration securities' spread-to-worst (STW) values. STW calculates the difference between the YTW of a bond and a U.S. Treasury security.

The equation for calculating YTC is the following:

• YTC = (coupon interest payment + (call price - market value) ÷ number of years until call) ÷ (( call price + market value ) ÷ 2 )

Analyzing Yields

Yields are typically always reported in annual terms. If a bond is not callable, the yield to maturity is the most important and appropriate yield for investors to use because there is no yield to call.

Yield to maturity is calculated from the following equation:

If a bond is callable, it becomes important to look at the YTW. The yield to maturity will always be higher than the YTW because the investor earns more when they hold the bond for its full maturity. The YTW is important though because it provides deeper due diligence on a bond with a call provision. The shorter time frame a bond is held for, the less the investor earns. YTW provides a clear calculation of this potential scenario showing the lowest yield possible.

Some other types of yield that an investor might also want to consider include: running yield and nominal yield.