Current Yield

Definition

Current yield is a metric used to evaluate the annual income generated by a bond relative to its current market price. It represents the percentage return an investor would receive if they purchased the bond and held it for one year, assuming the bond's coupon payments remain unchanged.

5 Must Know Facts For Your Next Test

1. Current yield is calculated by dividing the bond's annual coupon payment by its current market price.
2. Current yield is a useful metric for comparing the income generated by different bonds, as it accounts for the bond's current market price rather than just its par value.
3. Unlike yield to maturity, current yield does not consider the time value of money or the bond's capital appreciation or depreciation.
4. Current yield is particularly relevant for investors who are primarily interested in the bond's income-generating potential rather than its total return.
5. Current yield can fluctuate over time as a bond's market price changes, even if the coupon rate remains constant.

Review Questions

• Explain how current yield is calculated and how it differs from the bond's coupon rate.
  • Current yield is calculated by dividing the bond's annual coupon payment by its current market price. This metric differs from the bond's coupon rate, which is the fixed interest rate paid by the issuer, because current yield takes into account the bond's current market price rather than just its par value. While the coupon rate remains constant throughout the bond's life, the current yield can fluctuate as the bond's market price changes.
• Describe the significance of current yield in the context of bond valuation and how it relates to an investor's investment objectives.
  • Current yield is an important consideration in bond valuation because it provides a measure of the annual income generated by a bond relative to its current market price. This metric is particularly relevant for investors who are primarily interested in the bond's income-generating potential, rather than its total return. By comparing the current yields of different bonds, investors can assess which bonds offer the most attractive annual income based on their current market prices.
• Analyze how changes in a bond's market price can affect its current yield, and explain the implications for an investor's decision-making process.
  • As a bond's market price fluctuates, its current yield will also change, even if the bond's coupon rate remains constant. If a bond's market price increases, its current yield will decrease, and vice versa. This inverse relationship between a bond's market price and its current yield has important implications for investors. Investors who are focused on maximizing their annual income may be inclined to sell bonds with declining current yields and purchase bonds with higher current yields, in order to maintain their desired level of income. However, this strategy may not align with the investor's overall investment objectives, which may include capital appreciation or total return. Therefore, investors must carefully consider the trade-offs between current yield and other factors, such as yield to maturity and risk, when making bond investment decisions.

Related terms

Bond Valuation: The process of determining the fair price of a bond based on its future cash flows, time to maturity, and prevailing interest rates.

Coupon Rate: The fixed interest rate that a bond issuer pays to bondholders, typically expressed as a percentage of the bond's par value.

Yield to Maturity: The total return an investor will receive if a bond is held until its maturity date, taking into account the bond's current market price, coupon rate, and time to maturity.