- Yield to Call
1 1.1 If you purchased a bond that was callable and the company called it, you would
not have the option of holding it until it matured. Therefore, the yield to maturity
would not be earned.
11.2 If current interest rates are well below an outstanding bond’s coupon rate, then a
callable bond is likely to be called, and investors will estimate its most likely rate
of return as the yield to call (YTC) rather than as the yield to maturity.
- Current Yield
12.1 If you examine brokerage house reports on bonds, you will often see reference to
a bond’s current yield,. The current yield is the annual interest payment divided
by the bond’s current price.
12.2 Unlike the yield to maturity, the current yield does not generally repr4esent the
return that investors should expect form holding the bond. The current yield
provides information about the cash income a bond will generate in a given year,
but since it does not take account of capital gains or losses that will be realized if
the bond is held until maturity (or call), it does not provide an accurate measure of
the total expected return.
12.3 The fact that the current yield does not provide an accurate measure of the total
return can be illustrated with a zero coupon bond. Since zeros pay no annual
income, they always have a current yield of zero. This indicates that the bond
will not provide any cash interest income, but since it will appreciate in value over
time, its total return clearly exceeds zero.
12.4 Although some bonds pay interest annually, the vast majority actually pay interest
semiannually.
- Interest rate risk
13.1 Interest rates go up and down over time, and an increase in interest rates leads to a
decline in the value of an outstanding bond. This risk of a decline in bond values
due to rising interest rates is called interest rate risk. Interest rates can and do
rise, and rising rates cause a loss of value for bound holders. Thus, people or
firms who invest in bonds are exposed to risk from changing interest rates.
13.2 One’s exposure to interest rate risk is higher on bonds with long maturities than
on those maturing in the near future.
13.3 The longer the maturity of the bond, the more its price changes in response to a
given change in interest rates. Even if the risk of default on two bonds is exactly