What is yield to worst?

What is yield to worst?

• A. The lowest possible yield among call, put, or maturity outcomes.
• B. The highest possible yield among outcomes.
• C. The yield to wage tax.
• D. The yield to weather risk.

Answer: (A)

Yield to worst is the lowest yield you could end up receiving on a bond that has embedded options, once you consider all the possible outcomes the issuer might trigger—holding to maturity, being called, or being put back to the investor. To see it, you compute the yield to each relevant event date: yield to maturity, yield to any call dates, and yield to any put dates, assuming you hold the security until that date and receive the expected cash flows. The yield to worst is simply the smallest of those yields. This is the best answer because it represents the investor’s pessimistic, or worst-case, scenario given the bond’s features. It’s especially important for callable bonds: if rates drop, the issuer might call the bond early, which often results in you receiving less than you’d expect if you held to maturity. Yield to worst captures that risk in a single figure for comparing bonds with different call or put provisions. Other options don’t fit because they refer to concepts that aren’t standard measures for fixed-income risk (yield to wage tax, yield to weather risk), or they describe a best-case or non-standard metric (the highest yield).

Yield to worst is the lowest yield you could end up receiving on a bond that has embedded options, once you consider all the possible outcomes the issuer might trigger—holding to maturity, being called, or being put back to the investor.

To see it, you compute the yield to each relevant event date: yield to maturity, yield to any call dates, and yield to any put dates, assuming you hold the security until that date and receive the expected cash flows. The yield to worst is simply the smallest of those yields.

This is the best answer because it represents the investor’s pessimistic, or worst-case, scenario given the bond’s features. It’s especially important for callable bonds: if rates drop, the issuer might call the bond early, which often results in you receiving less than you’d expect if you held to maturity. Yield to worst captures that risk in a single figure for comparing bonds with different call or put provisions.

Other options don’t fit because they refer to concepts that aren’t standard measures for fixed-income risk (yield to wage tax, yield to weather risk), or they describe a best-case or non-standard metric (the highest yield).