Current yield

Definition

Current yield is a financial metric used to measure the annual income generated by a bond, expressed as a percentage of its current market price. It connects the bond's annual coupon payment to its current trading price, offering investors a quick way to gauge the return they might expect from purchasing the bond at that moment. This yield is particularly important for understanding how market conditions affect bond pricing and investor returns.

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, which gives a quick snapshot of the income relative to what you would pay for the bond now.
2. This yield helps investors assess whether a bond is overvalued or undervalued compared to its income potential, especially in fluctuating interest rate environments.
3. Current yield does not take into account any potential capital gains or losses that could occur if the bond is held until maturity.
4. Investors often use current yield in conjunction with other metrics like yield to maturity and coupon rate for a more comprehensive evaluation of a bond's performance.
5. The current yield will change as the market price of the bond fluctuates; if the price goes up, the current yield goes down, and vice versa.

Review Questions

• How does current yield provide insight into an investor's potential return on a bond compared to its market price?
  • Current yield offers investors a snapshot of how much income they can expect relative to what they would pay for a bond at its current market price. By calculating the annual coupon payment divided by this price, investors can quickly determine whether the bond is providing an attractive return at that moment. This is particularly useful when comparing different bonds or assessing market conditions that may affect pricing.
• In what scenarios might an investor prioritize current yield over other metrics like yield to maturity or coupon rate?
  • An investor might focus on current yield when looking for immediate income from bonds, especially if they are interested in short-term investments or are seeking to compare bonds based on their current pricing rather than their overall returns. In a rising interest rate environment, where bond prices may be falling, knowing the current yield helps in making quick decisions about whether to buy or sell bonds based on their immediate income potential.
• Evaluate how changes in interest rates influence current yield and what this means for investor strategy in a volatile market.
  • Changes in interest rates directly affect bond prices; when rates rise, existing bond prices typically fall, leading to an increase in current yield. Conversely, if rates decline, bond prices rise and current yields decrease. For investors, this means that monitoring interest rate trends is crucial for making informed decisions about buying or selling bonds. An investor might take advantage of rising yields in a high-interest environment by adjusting their portfolio to focus on bonds that offer greater current income while being cautious about potential capital losses on existing bonds.

Related terms

coupon rate:

The coupon rate is the fixed interest rate paid by a bond issuer to bondholders, typically 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 coupon payments and the difference between its purchase price and face value.

market price: Market price refers to the current trading price of a bond in the financial markets, which can fluctuate based on supply and demand, interest rates, and other economic factors.