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 or investment until maturity, assuming no change in the market price.
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Current yield is calculated by dividing the annual coupon payment by the bond's current market price.
Current yield is a useful metric for comparing the income-generating potential of different fixed-income investments, but it does not account for potential changes in the bond's market price.
Bonds with higher coupon rates will generally have a higher current yield, all else being equal.
As bond prices rise, the current yield will decrease, and vice versa, due to the inverse relationship between bond prices and yields.
Current yield is an important consideration for investors seeking a steady stream of 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 annual coupon payment of a bond by its current market price. This represents the annual income an investor would receive if they held the bond until maturity, assuming no change in the market price. In contrast, yield to maturity accounts for the total return an investor would receive, including both the coupon payments and any changes in the bond's market price over the life of the investment.
Describe how current yield is affected by changes in bond prices and coupon rates.
Current yield and bond prices have an inverse relationship. As bond prices rise, the current yield will decrease, and vice versa. This is because the annual coupon payment remains fixed, while the current market price of the bond changes. Additionally, bonds with higher coupon rates will generally have a higher current yield, all else being equal, as the annual income generated by the bond is greater.
Discuss the importance of current yield in the context of how households supply financial capital.
Current yield is an important consideration for households when supplying financial capital through investments in fixed-income securities, such as bonds. Households may prioritize investments that provide a steady stream of income, and current yield allows them to compare the income-generating potential of different fixed-income options. Additionally, understanding how current yield is affected by factors like bond prices and coupon rates can help households make informed decisions about the composition of their fixed-income portfolios and the trade-offs between income generation and capital appreciation.
The total return an investor would receive if they held a bond or fixed-income investment until its maturity date, accounting for both the coupon payments and any changes in the market price.