What is the Current Yield?
Current Yield is the return if an investor would hold a bond for a period of one year it is calculated as the annual cash flow divided by the market price, annual cash flow is the summation of interest or dividend received over one year and the market price is the current price.
Current Yield measures the return generated by the security relative to the current price and not on the original price. No matter what the original price of the security is; the current yield formula will only calculate the return on the current price. For example, let’s say that an investor has bought a bond at a price of $120. And the bond promises to return a 10% annual coupon, i.e. $12. However, the current price of the bond is $100. The bond yield is 10% still because it would be calculated on the original price. But the yield would be = ($12 / $100) = 12%.
Let’s take a practical example for a better understanding.
Betty has invested in two bonds. The original prices of these two bonds were $1000 and $1500. The risk for both of these bonds is similar. The annual coupons for each of these bonds are $150 and $180 respectively. The current prices of these bonds are $1200 and $1800 respectively. Find out the bond yield and current yield for each of these bonds. And on the basis of yield, which bond Betty should choose to invest in?
Let’s find out the bond yield first.
- The bond yield for the first bond is = $150 / $1000 = 15%.
- The bond yield for the second bond is = $180 / $1500 = 12%.
Now, we will calculate the current yield of a bond. We have been given the current prices and the same annual coupons will be applied.
- The yield of the first bond is = $150 / $1200 = 12.5%.
- The yield of the second bond is = $180 / $1800 = 10%.
On the basis of yield, Betty should choose to invest in the first bond. Since both of these bonds are similar in terms of risk, we can easily say that the first bond will be the best among the two.
How to Use the Formula of Current Yield?
For an investor, higher risk should result in a higher return. That’s why whenever she looks at multiple investments; she needs multiple ratios to judge the worthiness of each investment.
In regards to bond investments, investors look at quite a few ratios – current yield of a bond, yield to maturity, yield to call, etc. The current yield of a bond is specifically used to see how two risky investments turn out in the same measuring grid.
Investors always look for premiums for taking higher risks. If it so happens that the investors have the option to choose one from two high-risk bond investments, then the investors will only choose the one that pays more return. That’s why it is being used and is such an important indicator.
Current Yield Calculator
You can use the following Calculator
|Current Yield Formula =||
Calculate Current Yield in Excel
Let us now do the same example above in Excel. You need to provide the two inputs of First Bond and Second Bond.
Now, we will see the calculation. Current Prices and the same Annual Coupons will be applied.
You can download this template here – Current Yield Excel Template
Current Yield Video
This has been a guide to Current Yield and its definition. Here we discuss the formula to calculate current yield along with practical examples and excel templates. You may also look at the following articles to enhance your fixed-income skills.