What Does YTW Mean in Investments?
In the investing world, YTW stands for Yield to Worst. YTW is the lowest potential yield you may receive from a bond, assuming the issuer does not default. If the bond has call provisions, YTW calculations assume that the bond will be called, prepaid. If the call provisions permit the issuer to reduce the coupon rate to below market levels, the YTW displays the lowest possible yield you'd receive in worst case scenarios.
The YTW acts as a measure by which investors can identify the lowest possible yield from their bond acquisitions barring default.
Understanding Yield to Call
Bonds often have multiple call dates, when the issuer can pay off the bond principal and accrued interest before maturity. Investors calculate yield to calls, YTC, for each call date on remaining bond terms. In this case, YTW equals the lowest possible return at all call dates, assuming the issuer redeems the bond at the next or additional stated call dates.
Exploring Yield to Maturity
Yield to Maturity, commonly called YTM, is the effective yield you will earn if you held the bond to its stated maturity. For example, you purchase a 10-year bond in its third year. The YTM is your projected yield if you hold the bond for the next seven years, when it will mature, paying you the principal and all interest due. Many investors also calculate YTW as of the bond's stated maturity.
Evaluating Callable Bonds
YTW is most important when you own callable bonds. Common terms for callable bonds include an annual coupon payment and call date. For example, a $1,000 bond with a 5 percent coupon rate and three years to maturity cost you $1,012. The bond makes annual coupon payments, but it's callable in one year. The YTM is 4.56 percent and the YTC is 3.75 percent. In this example, YTW is also 3.75 percent, as the worst case scenario is that the issuer calls the bond in one year.
The Significance of YTW
The YTW is vital to investors, particularly those with callable bonds. For example, if current interest rates decline below a callable bond's coupon rate, issuers often call these bonds at the next call date so they can reissue them at lower rates. Calculating the YTW gives investors a valuable snapshot of what their minimum yield will be if the bond is called, leaving them to find other investments.
Other Relevant Considerations
YTW is not helpful in all situations. For example, consider zero coupon bonds. Since these guarantee no periodic interest payments, they are typically sold at deep discounts from their face value. Since there is no stated interest rate, or coupon, YTW calculations mean little. You decide the lowest yield you'll accept and value the bond accordingly.