Current Yield vs. Yield to Call vs. Yield to Worst

Preferred stock and baby bond listings typically display several yield figures, and conflating them is among the most common errors new income investors make. Each measure answers a different question, and using the wrong one can lead an investor to overstate the return a security is likely to deliver, sometimes substantially. Current yield is the simplest calculation: the annual dividend or coupon divided by the current market price. A preferred paying $1.50 annually and trading at $24.00 carries a current yield of 6.25%. The measure answers the question, "What am I earning today, at today's price, if nothing changes?" It says nothing about what happens if the issuer calls the security away, nothing about the passage of time toward a maturity date, and it can be actively misleading for a security trading well above or below par. Yield to call measures the total annualized return an investor would receive if the security is redeemed by the issuer on its first available call date, accounting for both the income received and any capital gain or loss between the purchase price and the $25 redemption price. Consider a preferred paying $1.75 annually, trading at $26.00, and callable in two years. Its current yield is an appealing 6.73%. But an investor who pays $26.00 and receives $25.00 at the call absorbs a $1.00 capital loss, roughly 50 cents a year, against $1.75 of annual income. The yield to call works out to approximately 4.8%, nearly two percentage points below the advertised current yield. The premium buyer is, in effect, prepaying a portion of the dividends. The arithmetic reverses below par. A security paying $1.25 annually and trading at $22.00 offers a current yield of 5.68%, but if called in two years the holder also collects a $3.00 capital gain, lifting the yield to call above 12%. Whether that outcome is probable is a separate question, and an important one: issuers rarely call securities whose coupons are below prevailing market rates, which is often precisely why such securities trade below par in the first place. Yield to worst is the more conservative of the forward-looking measures. It represents the lowest yield an investor can expect across all plausible redemption scenarios: called at the first date, called at any later date, or, for baby bonds, held to final maturity. It is the figure most professional fixed-income investors default to when evaluating a security, precisely because it does not assume the most favorable outcome. When a security trades above par, yield to worst typically equals yield to call; below par, it typically equals yield to maturity for dated securities or current yield for perpetuals. The measure's virtue is its pessimism: an investor who buys on yield to worst can be disappointed by outcomes only to the upside. Baby bonds introduce one further measure, yield to maturity, which incorporates the contractual return of principal at the stated maturity date. For a note trading at a discount with decades remaining, yield to maturity may exceed both current yield and yield to call, but realizing it requires holding through every intervening rate cycle, and assumes the issuer does not redeem early. Two practical habits follow from the arithmetic. First, never screen or rank income securities on current yield alone. A list sorted by current yield systematically surfaces securities trading at premiums with imminent call dates, the very securities most likely to deliver less than they advertise. Sorting by yield to worst inverts that bias in the investor's favor. Second, always note where a security trades relative to par before interpreting any yield figure, because the relationship between price and redemption value determines which measure governs. The yield a security displays is a matter of arithmetic; the yield an investor actually receives is a matter of which scenario unfolds, and disciplined analysis prices the least favorable one.