Yield to worst and reinvestment risk

Pricing and Yields · Bonds Explained

Compare the permitted redemption paths

Yield to worst commonly compares the yield to maturity with yields to applicable call dates and prices, using the lowest relevant result under the stated convention. Read which dates and terms the calculation includes. The word worst does not mean the largest possible loss.

Default, a forced sale or unexpected costs can produce an outcome below the quoted yield to worst. Treat the measure as a comparison of contractual redemption scenarios, not a guarantee.

Calculate the early call result

Imagine paying $1,080 for a hypothetical bond with $1,000 face value and an $80 annual coupon. It can be called at par in one year. If called after that coupon, total receipts are $1,080. The one year return is zero before costs.

The 8% coupon rate looks attractive in isolation. The call scenario reveals that the coupon merely offsets the purchase premium. A longer maturity calculation may show a positive yield, but it does not remove the issuer’s call right.

Follow the coupons after receipt

Reinvestment risk concerns the return available on money received before your investment horizon ends. Suppose a $50 coupon arrives with one year left until your planned spending date. Reinvesting at 2% grows it to $51. At 5%, it becomes $52.50.

The difference is $1.50 for that coupon. Across a large portfolio and many years, such differences accumulate. Spending the coupons produces a different wealth path from reinvesting them.

Test an income plan

Record the earliest call date and the amount you would need to reinvest if the bond is redeemed. Test a lower reinvestment rate instead of assuming today’s income continues. For complex call schedules, verify the full cash flow model rather than trusting one unexplained percentage on a screen.

Try it yourself

Why can a bond’s yield to worst be positive while an investor still loses money?

Show the worked answer

Yield to worst generally assumes contractual payments and specified redemption paths. Default, selling at a depressed price, transaction costs or other omitted factors can reduce the actual result.