Current Yield of a Bond

What is Current Yield of Bond ?

The current yield of a bond calculates the rate of return on a bond by using the market price of the bond instead of its face value. It is calculated as the annual coupon payment divided by the current market price The current yield is an accurate measure of bond yield as it reflects the market sentiment and investor expectations from the bond in terms of return.

Current Yield of a Bond Formula

Current Yield of Bond Formula = Annual Coupon Payment / Current Market Price

Current-Yield-of-Bond

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Source: Current Yield of a Bond (wallstreetmojo.com)

Understanding Current Yield of Bond

The relevance of the Current yield can be seen in the evaluation of multiple bonds of the same risk & maturity. The coupon rate of a bond usually remains the same; however, the changes in interest rate markets encourage investors to constantly change their required rate of returnRequired Rate Of ReturnRequired Rate of Return (RRR), also known as Hurdle Rate, is the minimum capital amount or return that an investor expects to receive from an investment. It is determined by, Required Rate of Return = (Expected Dividend Payment/Existing Stock Price) + Dividend Growth Rateread more (Current yield). As a result, bond pricesBond PricesThe bond pricing formula calculates the present value of the probable future cash flows, which include coupon payments and the par value, which is the redemption amount at maturity. The yield to maturity (YTM) refers to the rate of interest used to discount future cash flows.read more fluctuate, and prices increase/decrease as per the required rate of return of the investors.

The current yield of a discount bond is greater than the annual coupon rate because of the inverse relationship that exists between the yield of a bond and its market price. Similarly, the yield on a premium bond is lower than its annual coupon rate and equal for a par bond. The reason why current yield fluctuates and deviates from the annual coupon rate is because of the changes in interest rate market dynamics based on Inflation expectations of the investors.

Current yield, when used with other measures such as YTM, Yield to the first call, etc. helps the investor in making the well-informed investment decision.

Examples

You can download this Current Yield of Bond Formula Excel Template here – Current Yield of Bond Formula Excel Template

Example #1

Suppose there are two Bonds. Bond A & B. The details are as follows:

ParticularsBond ABond B
Face Value10001000
Current Market Price1200900
Annual Coupon Rate10%10%

The current yield of A & B Bond will be calculated as follows:

For Bond A

Step 1:  Calculate Annual coupon payment

Current Yield of Bond Example 1.2
  • Face value * Annual coupon rate
  • 1000 * 10%
  • = 100

Step 2:  Calculate Current Yield

Current Yield of Bond Example 1.3
  • = Annual coupon payment / Current market price
  • = 100 / 1200
Current Yield of Bond Example 1.6
  • = 8.33%

For Bond B

Step 1: Calculate Annual coupon payment

Current Yield of Bond Example 1.4
  • = Face value * Annual coupon rate
  • = 1000 * 10%
  • = 100

Step 2:  Calculate Current Yield

Current Yield of Bond Example 1.5
  • = Annual coupon payment / Current market price
  • = 100 / 900
  • = 11.11%

Example #2

Let us now analyze how current yield differs under various scenarios for a bond.

ParticularsDiscount BondPremium bond Par bond
Face Value100010001000
Current market price95010501000
Annual coupon rate10%10%10%
Annual coupon payment100100100

Scenario #1: Discount Bond

Suppose the Bond is trading at a discount, meaning the current market price is lesser than the face value.

Current Yield of Bond Example 2.1

In this case, the current yield will be;

Current Yield of Bond Example 2.2
  • = Annual coupon payment / Current market price
  • = 100/ 950
  • = 10.53%

Scenario #2: Premium bondPremium BondPremium bonds are those long-term financial instruments which trade at a price exceeding their face value. The coupon rate of these bonds is higher because they tend to provide more interest than the standard rate of interest prevailing in the market.read more

Suppose B is trading at a premium, meaning the current market price is greater than the face value.

Example 2.3

In this case, the current yield on a Premium bond will be;

Example 2.4
  • = Annual coupon payment / Current market price
  • = 100/ 1200
  • = 9.52%

Scenario #3: Par bond

Here the current market price is equal to the face value.

Example 2.5

In this case, the current yield on a par bond will be;

Example 2.6
  • = Annual coupon payment / Current market price
  • = 100/ 1000
  • = 10%

The above relationship can be understood in the below table:

Example 2.7

A well-informed investor relies on various types of calculations to better analyze the multiple investment opportunities and decide which opportunity to pursue. Some of the calculations that are relevant for the bond market are Yield to maturityYield To MaturityYield to Maturity refers to the expected returns an investor anticipates after keeping the bond intact till the maturity date. In other words, a bond's expected returns after making all the payments on time throughout the life of a bond.read more, Current Yield, Yield to the first call, etc.

Example #3

Suppose an investor wants to invest in the Bond market and shortlists two bonds according to his risk toleranceRisk ToleranceRisk tolerance is the investors' potential and willingness to bear the uncertainties associated with their investment portfolios. It is influenced by multiple individual constraints like the investor's age, income, investment objective, responsibilities and financial condition.read more. Both bonds have the same level of risk & maturity. Based on the details provided below, which bond should the investor consider investing in?

BondAnnual coupon paymentFace valueCurrent market price
ABC10010001500
XYZ10010001200

Let us calculate the current yield of both bonds to determine which one is a good investment

For ABC

Example 3.2
  • = Annual coupon payment / Current market price
  • = 100/ 1500
  • =6.66%

For XYZ 

Example 3.3
  •  = Annual coupon payment / Current market price
  • = 100/ 1200
  • = 8.33%

Well, clearly, it is the Bond with a higher yield that attracts the investor, as it gives a higher return on Investment. Therefore, Investors will select bond XYZ for investment, as it offers a higher current yield of 8.33% as compared to 6.66% offered by ABC.

Relevance and Use

  • One of the essential use of the Current Yield is to identify the yield of a bond that reflects the market sentiment. As the current yield is calculated based on current market prices, it is said to be the accurate measure of yield and reflects the true market sentiment.
  • The Investor who wants to make an effective investment decision would rely on the current yield to make a well-informed decision. Suppose an investor is considering making an investment and founds Bond A & B. The bond with higher is more attractive to the investor.
  • It is considered to be a dynamic and fundamentally accurate measure as it keeps on changing as per the inflation expectations of the investors, as opposed to coupon rate that stays constant over the time period of the bond.
  • It is always higher for a discount bond, as investors demand a higher yield for the amount of risk they are taking by investing in it.

Recommended Articles

This has been a guide to what is Current Yield of a Bond and its meaning. Here we learn how to calculate the Current Yield using its formula along with examples. You can learn more about financial analysis from the following articles –

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