What it means
Some bonds can be repaid before their final maturity date, at the issuer's option. That creates several possible yields depending on when, or whether, the issuer calls the bond.
The yield to worst is the lowest of these possible yields, and it is the conservative figure an investor should plan on. The spread to worst takes that figure and compares it with a benchmark yield to show how much extra return the bond pays for its added risk.
The calculation is simple subtraction, and the result is usually quoted in basis points, where one basis point is one hundredth of a percentage point. This avoids confusion when yields are moving by small amounts.
A spread of 150 basis points therefore means 1.50% extra yield over the benchmark. Investors use the measure to compare bonds of different companies and maturities on a like-for-like basis.
A wider spread suggests the market sees the issuer as riskier or the bond as less liquid, while a narrower spread signals greater confidence. The benchmark should match the bond's worst-case life.
If the worst case is that the bond is repaid in three years, the comparison should be with a three-year government bond rather than a ten-year one, otherwise the spread mixes up credit risk with the difference between short and long interest rates. A nuance is that spread to worst can change without any change in the issuer's credit quality.
If market rates fall, a call becomes more likely, the worst case moves to an earlier date, and the measured spread can shift even though the company is unchanged.
In practice
Real-world examples.
Example
A fund manager compares two callable bonds with the same credit rating. The first has a spread to worst of 120 basis points and the second 180 basis points, so she investigates why the second pays more.
Example
A corporate treasurer looks at the spread to worst on the company's own callable bonds in the market. An increase from 150 to 220 basis points warns her that investors now regard the company as riskier, which may affect the cost of future borrowing.
Example
A credit analyst building a report for a pension scheme ranks a portfolio of bonds by spread to worst, using it to show how much extra return the scheme earns for the risk it carries.
Formula
Calculation
Spread to worst = yield to worst - benchmark yield
A corporate bond has a yield to worst of 5.60%, based on the issuer calling it in four years. The government bond for the same period yields 4.10%. Spread to worst = 5.60% - 4.10% = 1.50%, which is 150 basis points. If the benchmark yield later rose to 4.30% and the bond's yield to worst stayed at 5.60%, the spread would narrow to 130 basis points.Case study
Seen in the real world.
Falcon Rail is an illustrative, fictional company with a callable bond that can be repaid at the issuer's option after three years. The bond trades at a price above its face value, which makes an early call likely.
An investor looking at the yield to maturity of 6.20% thought the bond looked cheap compared with a government bond yielding 4.00%, a spread of 220 basis points. But the yield to worst, based on the call in three years, was only 5.30%, so the spread to worst was 5.30% - 4.00% = 1.30%, or 130 basis points.
The illustrative lesson is that the quoted maturity spread overstated the reward by 90 basis points. The investor used the spread to worst for the comparison and decided that other bonds offered better value for the risk. He also added a rule to his checklist that every callable bond must be assessed on its worst-case yield before any purchase.
Watch out
Common mistakes.
- Using the yield to maturity for a callable bond, when the worst-case yield is the safer figure.
- Comparing against a benchmark of the wrong maturity, which mixes credit risk with changes in interest rates.
- Reading a wider spread as always better, when it may simply reflect higher risk of the issuer failing to pay.
Questions
People also ask.
What is yield to worst?
It is the lowest yield an investor could receive from a bond if the issuer exercises any of its early repayment rights, or if the bond runs to maturity.
Why use basis points?
They avoid confusion between a percentage change and a change in percentage points, so 150 basis points is always exactly 1.50 percentage points.
Does a bond without a call option have a spread to worst?
It does, but the yield to worst is then simply the yield to maturity, so the figure is the same as the ordinary yield spread.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related