Current yield

Definition

Current yield is a financial metric that measures the annual income (interest or dividends) generated by an investment as a percentage of its current market price. This concept is essential for evaluating bond investments, as it provides insight into the income return relative to the bond's market value, helping investors assess the attractiveness of the bond compared to other investment opportunities.

5 Must Know Facts For Your Next Test

1. Current yield is calculated by dividing the annual coupon payment by the bond's current market price, allowing investors to see how much income they can expect based on the current valuation.
2. This metric can vary significantly from the coupon rate if the market price of the bond fluctuates due to changes in interest rates or credit quality.
3. Current yield does not consider any capital gains or losses that may occur if the bond is sold before maturity or if it is redeemed at face value, which can impact total returns.
4. Investors often use current yield as a quick assessment tool to compare the income potential of various bonds against other investment options in the market.
5. Current yield can be particularly useful in a rising interest rate environment, where bonds may trade at discounts, thus increasing their current yield despite potentially lower overall yields.

Review Questions

• How does current yield help investors make decisions about bond investments?
  • Current yield provides a straightforward way for investors to evaluate the income generated by a bond relative to its current market price. By focusing on this metric, investors can quickly determine whether a bond offers an attractive income return compared to others in the market. This helps them make informed decisions about which bonds might fit their investment strategies based on yield performance.
• Discuss how changes in market interest rates influence current yield and its relationship with coupon rate.
  • When market interest rates rise, existing bonds with lower coupon rates typically sell at a discount, leading to an increase in current yield. Conversely, if interest rates fall, those same bonds may trade at a premium, reducing their current yield. This dynamic illustrates how current yield can diverge from coupon rate, making it essential for investors to understand both metrics when assessing bonds in varying interest rate environments.
• Evaluate the significance of current yield in relation to overall bond performance and investor strategy during periods of economic uncertainty.
  • In times of economic uncertainty, current yield becomes particularly significant for investors seeking stable income. It allows them to gauge how much income they can expect from bonds based on current prices without needing to hold them until maturity. This focus on current yield helps investors balance their portfolios and adjust their strategies based on prevailing market conditions and interest rates, while also considering potential risks associated with bond investments.

Related terms

coupon rate:

The coupon rate is the fixed annual interest payment that a bond issuer pays to bondholders, expressed as a percentage of the bond's face value.

yield to maturity:

Yield to maturity (YTM) is the total expected return on a bond if it is held until it matures, taking into account all future coupon payments and any difference between the purchase price and the face value.

bond discount: A bond discount occurs when a bond is sold for less than its face value, often due to rising interest rates or declining creditworthiness of the issuer.