key term - Current Yield

Definition

Current yield is a measure of the annual income generated by a bond or other fixed-income investment, expressed as a percentage of the investment's current market price. It represents the return an investor would receive if they held the bond until maturity and the issuer made all scheduled interest payments.

5 Must Know Facts For Your Next Test

1. Current yield is calculated by dividing the bond's annual interest payment by its current market price.
2. Current yield is useful for comparing the income generated by different fixed-income investments, but it does not account for the potential capital gains or losses from changes in the bond's price.
3. Bonds with higher coupon rates tend to have higher current yields, all else being equal.
4. As bond prices rise, the current yield decreases, and vice versa, due to the inverse relationship between bond prices and yields.
5. Current yield is an important consideration for investors seeking regular income from their fixed-income portfolio.

Review Questions

• Explain how current yield is calculated and how it differs from yield to maturity.
  • Current yield is calculated by dividing the bond's annual interest payment (coupon rate) by its current market price. This represents the annual income an investor would receive if they purchased the bond at the current price and held it until maturity, assuming all scheduled interest payments are made. In contrast, yield to maturity accounts for the bond's current market price, coupon rate, and time remaining until maturity, providing a more comprehensive measure of the bond's total return.
• Describe the relationship between bond prices and current yield, and how this affects investors' decision-making.
  • There is an inverse relationship between bond prices and current yield. As bond prices rise, the current yield decreases, and vice versa. This is because the coupon rate remains fixed, but the current market price changes. Investors seeking higher current income may be drawn to bonds with higher current yields, but this may come at the expense of potential capital appreciation if bond prices subsequently decline. Conversely, investors focused on total return may be willing to accept a lower current yield in exchange for the potential for capital gains if bond prices increase.
• Analyze how the current yield of a bond may be affected by changes in the bond's coupon rate or market price, and discuss the implications for investors.
  • The current yield of a bond is directly affected by changes in the bond's coupon rate and market price. If a bond's coupon rate increases, its current yield will also increase, all else being equal. Conversely, if the bond's market price rises, its current yield will decrease, even though the coupon rate remains the same. These changes in current yield can have significant implications for investors. Investors seeking higher current income may be drawn to bonds with higher current yields, but they must also consider the potential for capital gains or losses if the bond's price changes. Conversely, investors focused on total return may be willing to accept a lower current yield in exchange for the potential for capital appreciation. Understanding the relationship between current yield, coupon rate, and bond prices is crucial for investors to make informed decisions about their fixed-income investments.

Related terms

Yield to Maturity:

The total return an investor would receive if they held a bond until its maturity date, accounting for the bond's current market price, coupon rate, and time remaining until maturity.

Coupon Rate: The fixed interest rate paid on a bond, typically expressed as a percentage of the bond's face value and paid to the bondholder at regular intervals.

Bond Price: The current market value of a bond, which fluctuates based on factors such as interest rates, credit risk, and time to maturity.