The annual income earned from an investment is called a yield and is expressed as a percentage of the money invested. How much of a yield any investor will realize varies depending upon maturity date, bond price and other factors. The calculation of yield-to-call and yield-to-worst help give investors a way to determine just how much can be earned on a bond.
Yield-to-call is the yield on a bond or note if the issuer were to hold it, or redeem it, on the first call date specified in the bond's prospectus. A call date is the date by which a callable bond can be redeemed by the issuer prior to the maturity date. To redeem the bond on a yield-to-call, the issuer will pay the call price, which is a price greater than the face value of the bond.
Yield-to-worst refers to the lowest possible yield that can be received from a bond. It's calculated using the lower of either the yield-to-maturity or any yield-to-call. Yield-to-maturity refers to the average annual yield of the bond if it were held to the date of maturity. Yield-to-call gives an idea of the worst-case scenario of redemption of the bond at any point in time up to and including holding it to the date of maturity.
A yield-to-call calculation looks at three possible sources of returns: capital gains, coupon payments, which are periodic interest payments the bondholder receives, and reinvestment returns. Still, it is considered a less precise measurement of yield than yield-to-maturity because it makes the assumption that the the investor can reinvest the coupon payments at a rate that's equal to the yield-to-call. It's also considered less precise because it assumes the issuer of the bond will call it on the exact date used in the calculation and that the investor will actually hold the bond until its called.
At any price, the yield of a callable bond is lower than its yield-to-maturity. The reason is due to the call provisions inherent within callable bonds. Call provisions limit the potential appreciation, or increase in value, of the bond. When interest rates drop, which normally would allow for an appreciation in bond value, the yield of the callable bond cannot rise higher than its call price. The issuer calls the bond without allowing it to exceed the call price, because doing so is in the best interest of the company since it saves the company money.