Question

22. Explain the following yield concepts: Yield to call, yield to put yield to maturity, cash flow yield. (8 pts.)

Answer 1

Yield to Call : Under this arrangements are made for a bondholder to return securities on the date of call prior to date of maturity. Accordingly the returns received by investor from the date of purchase till the date of call (which is prior to date of maturity). Generally the bonds are called over several years of time and normally called at a premium price. The bonds are bought at current market price. The yield is computed based on compound interest rate at which present value of future payments and call price is equal to the current market price.

Yield to Put : This is an annual yield on bonds which are put which means sold on first put date available immediately after the purchase date. The yield normally includes appreciation of securities and interest accumulated from the date of purchase till the put date. Generally these bonds are sold at a price lower than put price (market price on put date) because the sale or put is done at the option of investor.

Yield to Maturity : It is an total return anticipated from an bond from the date of purchase till the date of maturity of such bond. IRR (internal rate of return) earned by the buyer of bond at the market price, assuming that the bond is held until maturity, and that all the coupon and principal payments are made according to the schedule. This is the rate at which the sum of all future cash flows from the bond (both coupon and principal) is equal to the current price of the bond. This can be sold on par or at discount or at premium based on its coupon rate which is required to be equal to YTM or less than YTM or higher than YTM.

Cash Flow Yield : This yield is calculated by subtracting net cash flow from operating activities and dividing the result by net income. This ratio shows how well a company is earning from its operations. However this is also know as mortgage yield if we consider particularly with the yield concept. Which says the value of a mortgage backed bond is the monthly compounded discount rate at which NPV (net present value) of all its future cash flows will be equal to the present price of the bond.