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Current Yield of a Bond

Updated on January 5, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

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.

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

It is essential to keep in mind that the current yield is a primary metric and doesn’t consider factors like changes in interest rates or the bond’s maturity. Investors should also assess other metrics to make informed investment decisions. For instance, the yield to maturity provides a more comprehensive picture, considering all relevant factors for a bond held until maturity.

Key Takeaways

  • The current yield of a bond is a measure of its return based on the annual interest payments relative to its current market price. It is calculated by dividing the bond’s annual coupon payment by its current market price.
  • Current yield gives investors an estimate of the income a bond generates about its price. It helps assess the bond’s cash flow potential and can be compared to the yields of other investment options.
  • Current yield is influenced by both the bond’s coupon rate and its market price.
  • Current yield is a simple measure that does not consider the time value of money or the bond’s future cash flows, such as the return of principal at maturity.

Current Yield of Bond Explained

The Current yield of a bond’s relevance 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.

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The current yield of a discount bondA Discount BondA discount bond is one that is issued for less than its face value. It also refers to bonds whose coupon rates are lower than the market interest rate and thus trade for less than their face value in the secondary market.read more 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 dynamicsMarket DynamicsMarket Dynamics is defined as the forces of market constituents responsible for the shift in the demand and supply curve and are therefore accountable for creating and reducing the demand and supply of a particular product.read more 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 a well-informed investment decision.

Formula

Let us understand the formula that shall act as a basis for our understanding of the current yield of a bond calculator through the discussion below.

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

How To Calculate?

Calculating the current yield of a bond is an essential skill for investors looking to assess the potential returns on their fixed-income investments. Here’s a step-by-step guide on how to calculate the current yield:

  • Current yield is a simple measure of a bond’s return, comparing the annual interest payment to the bond’s market price.
  • Find the bond’s current market price, which you can obtain from financial news sources or your broker.
  • Determine the bond’s annual interest payment, also known as the coupon payment.
  • Divide the annual interest payment by the bond’s current market price.
  • Current Yield = (Annual Interest Payment / Bond’s Market Price) x 100
  • The current yield is expressed as a percentage, representing the bond’s yield based on its current market value.

Explanation Video of Current Yield

 

Examples

Now that we understand the basics, formula, and how to calculate using the current yield of a bond calculator, let us apply the theoretical knowledge to practical application through the examples below.

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 BondA premium bond refers to a financial instrument that trades in the secondary market at a price exceeding its face value. This occurs when a bond’s coupon rate surpasses its prevailing market rate of interest. For instance, a bond with a face value (par value) of $750, trading at $780, will reflect that the bond is trading at a premium of $30 ($780-750). 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 MaturityThe yield 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 returns are scheduled after making all the payments on time throughout the life of a bond. Unlike current yield, which measures the present value of the bond, the yield to maturity measures the value of the bond at the end of the term 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

Current Yield of a Bond Vs Yield to Maturity

Distinguishing between the current yield of a bond and the yield to maturity is crucial for investors seeking a comprehensive understanding of their bond investments. Below is a detailed comparison of both these metrics.

Current Yield of a Bond

  • Current yield is a straightforward measure of a bond’s return and is calculated by dividing the annual interest payment by the bond’s current market price.
  • It provides a snapshot of the bond’s yield based on its current market value.
  • It’s expressed as a percentage and offers a quick assessment of the income generated by the bond.
  • Current yield does not consider the bond’s price fluctuations, time to maturity, or reinvestment of coupon payments.
  • It is handy for investors looking to gauge the short-term income potential of a bond.

Yield to Maturity

  • Yield to maturity is a more comprehensive measure that considers the bond’s total return if held until maturity.
  • It factors in the bond’s current market price, coupon payments, and the difference between the purchase price and the face value of the bond.
  • YTM accounts for the effects of price changes, the reinvestment of coupon payments, and the time value of money.
  • It provides a more accurate reflection of the bond’s overall profitability, taking into account both income and capital gains or losses.
  • YTM is essential for investors with a long-term investment horizon, as it reflects the bond’s potential return over the entire holding period.

Frequently Asked Questions (FAQs)

How is the current yield of a bond different from yield to maturity (YTM)?

The current yield represents the bond’s return based on its market price and annual coupon payment. On the other hand, yield to maturity considers the bond’s entire cash flow stream, including all coupon payments and the principal repayment at maturity, and considers the time value of money.

Does the current yield of a bond consider reinvestment of coupon payments?

No, the current yield does not account for the reinvestment of coupon payments. It assumes that the coupon payments are received and kept as cash without reinvesting them at a potentially different interest rate. As a result, the actual total return of the bond may differ from the current yield.

What are the limitations of using the current yield of a bond?

While current yield is a useful measure to assess the income-generating potential of a bond, it has some limitations. It does not consider the bond’s duration, maturity, or potential changes in interest rates, which can impact the bond’s total return. 

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