Yield to Worst (YTW)
Yield to worst (YTW) is an indicator measuring the least possible yield receivable from a bond that completely performs under the terms of the agreement without defaulting. Yield to worst is a yield that is used when bonds have clauses allowing the issuer to close them out before the maturity date. Early bond redemption can be enforced through several provisions carefully laid out in the contract of the bond—most often callability. Yield to worst is a measure that is used to estimate the worst-case yield variant at the earliest possible date. Yield to worst facilitates investor risk management and ensures that certain income requirements are met even in the worst of situations.
What is Yield to Worst
The calculation of the yield to worst of a bond is provided on the basis of the earliest date of call or redemption. It is expected that the early repayment of the principal debt is carried out using the call option by the bond issuer. After the call, the principal amount is returned and coupon payments are terminated. In the case when yields decline and the issuer can get a coupon rate at a lower value through a new issue under current market conditions, an issuer will likely exercise their callable option.
Yield to worst can also be attributed to yield to call (YTC). With the purpose of identifying the yield to worst, the first step for an investor should be calculating the indicators - yield to call and yield to maturity. In principle, the value of yield to the worst can be at the level of the value of yield to maturity, however, it can never exceed it. This is because yield to worst is the investor's yield at the date before the date this debt instrument fully matures. Yield to worst constitutes the return for a shorter investment period, inherently.
Yield to worst is the lowest possible yield of an investor, which might be received from holding a particular bond that completely performs under the terms of the agreement without defaulting.
How Yield to Worst works
The yield to call is a yearly rate of return, indicating that the issuer redeems the bond on the earliest possible callable date. When the issuer has the opportunity to buy back the bond before its maturity date, then such a bond is called a callable bond. The values of the yield to call and yield to maturity are higher than the value of yield to worst. Under a put provision, the bond can be sold back by the investor to the company at a certain price and on a certain date. Since the decision about selling the bond is carried out by the investor, the existing yield to put is not taken into account in the yield to worst.
To calculate YTC the next formula is used:
The designation of yield is made on an annual basis. For a non-callable bond, the yield to maturity is the most important type of yield for an investor.
To figure out the yield to maturity, the next formula should be used:
In the event of a callable bond, yield to worst is also very important. The value of YTW (YTC) will always be below yield to maturity, since the investor's earnings are higher if the bond is held to maturity.
The yield to worst is a significant metric since it provides a deeper check on a bond with a call provision. The longer the term of holding the bond, the greater the investor's earnings. The yield to worst shows an accurate calculation of the potential variant, describing the smallest possible yield.
