The Current Yield on a bond represents the percentage return an investor can expect to earn over the next year if they purchase the bond at its current market price. It provides a snapshot of the bond’s income-generating potential relative to its market value.
Formula for Current Yield
The current yield is calculated using the formula:
Current Yield = Annual Coupon Interest / Current Market Price of the Bond
The annual coupon interest is determined by the bond’s coupon rate, which is set when the bond is issued and remains unchanged throughout the bond’s lifespan. It’s important to note that the current yield is based on the bond’s current market price, not its face value. As the bond’s market price fluctuates, the current yield will also change.
Understanding Coupon Yield
The Coupon Yield or Coupon Rate is the fixed annual interest rate paid by the bond issuer, based on the bond’s face value. While this rate remains constant, the bond’s market price may vary, affecting the current yield.
Why Current Yield Matters
Current yield is a valuable metric because it reflects the bond’s profitability in the current market. It helps investors compare the income potential of different bonds and make informed investment decisions.
Example Calculation
Consider a bond with the following details:
- Coupon Rate: 8%
- Face Value: Rs. 1,000
- Market Price: Rs. 950
The formula for calculating current yield is:
Current yield = annual coupon interest / bond price
Current yield= (8%×1000) ÷950 =8.42%
Key Takeaways
- Annual Coupon Interest is the total yearly payment from the bond.
- Bond Price refers to the bond’s current market price, not its face value.
- Current Yield helps investors evaluate the income return from a bond relative to its price.
By understanding how to calculate and interpret current yield, investors can better assess the income potential of their bond investments.
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