The yield to maturity measures the effective interest rate on a bond and assumes that you continue to reinvest the interest at the bond interest rate until the bond matures. However, some bonds carry a call feature, which allows the issuer of the bond to cash it in after a specified period of time if it chooses. For example, if interest rates fall, the issuer will call the bond and then issue a new one at the lower rates. Therefore, instead of using the maturity date, investors often use the call date.
1. Subtract the price paid for the bond from the face value. For example, if you paid $99 for a bond with a face value of $100, subtract $99 from $100 to get $1.
2. Divide the result by the number of years remaining until the bond can be called. In this example, if the bond can be called in five years, divide 1 by 5 to get 0.2.
3. Add the result to the coupon payment. In this example, if the coupon payment equals $6, add 0.2 to 6 to get $6.20.
4. Add the face value to the price paid and divide the result by two to find the average. In this example, add $99 plus $100 to get $199 and divide the result by $2 to get $99.50.
5. Divide the Step 3 result by the Step 4 result to calculate the yield to call for the bond. In this example, divide $6.20 by $99.50 to get 0.0623, or a yield to maturity of 6.23 percent.
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