Callable Bond Prices, Accrued Interest, and Yield Conventions
Summary
The document clarifies how a bond callable at par shortly before maturity handles its final coupon and how to interpret its quoted yield. The call price is the clean price; when the issuer calls the bond, the holder also receives accrued interest. Economically, that payment is equivalent to selling the bond in the secondary market at a clean price equal to the call strike, so the call does not simply erase the final coupon.
Issuers may call near-maturity bonds to arrange repayment conveniently or avoid holding repayment funds while continuing to pay interest. A quoted yield must be read together with its convention: yield to maturity ignores the call, while yield to call assumes the call occurs, and yield to worst reports the least favorable of the applicable outcomes. The examples illustrate the confusion that can arise when a yield is read without its label. The explanation does not calculate a bond’s option-adjusted value or predict whether a particular issuer will call.
Key ideas
- A par call price is a clean price, and accrued interest is paid in addition.
- Calling a bond near maturity can simplify repayment and cash management for the issuer.
- Yield to maturity does not account for a possible call.
- Yield to call and yield to worst use different assumptions about redemption.
- A quoted yield alone does not establish whether the bond will be called.
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Full text
# Misleading Yield (Callable Bonds with call price 100) # Misleading Yield (Callable Bonds with call price 100) When looking at Callable Bonds, I've noticed that we often have a call price of 100 with a call date a few month before expiry. For example: - `US09681MAS70`: coupon `2.625%`, expiry `2030-09-17`, callable from `2030-06-17` for `$100.0` - `FR0013509627`: coupon `2.000%`, expiry `2024-10-24`, callable from `2024-07-24` for `€100.0` It seems one implication of this is that the bond holder will never actually receive `100 + coupon` on expiry, as the issuer will always call the bond for `100` before that. Or in other words, the final coupon is effectively 0? Questions: - Why are callable bonds (often) structured like this? Why not set the final call price to `100 + coupon`? Or simply shorten the bond by one payment period (as we are skipping the final coupon anyway)? - If the (dirty) price of `FR0013509627` is `106.30` with quoted yield `0.65%`, then this yield calculation (via Street Convention) assumes no callable features (i.e. the yield calculation assumes the final coupon gets paid). Doesn't this mean the quoted yield is misleading? Since the bond will never actually pay the final coupon, shouldn't the effective yield be lower? E.g. somewhere around `0.15%`? ## Answer by Dimitri Vulis (score 4, accepted) https://quant.stackexchange.com/a/58686 The strike in these examples is the clean price. If a bond is called, then the bond holder receives the strike plus the accrued interest. It's exactly as if the bond hold sold the bond in the secondary market for clean price = strike. Bonds are frequently issued to be callable at par in the last few months of their lives for convenience: the issuer expects to raise the money needed to repay the bonds a little before maturity, and don't want to hold on to this money and pay interest until the last day. (Also sometimes shortly before the maturity some issuers has some regulatory / accounting requirements to jump through certain liquidity hoops, and it may be more convenient to exercise the call even if it looks a little out of the money.) Generally, a yield quoted for a callable bond is tagged "yield to maturity" (which ignores the call), "yield to call" (which assumes that the call will be exercised), "yield to worst", etc. It is not safe to look at YTM and to assume that the call won't be exercised.
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