Current yield

Definition

Current yield is a financial metric that measures the annual income (interest or dividends) generated by an investment relative to its current market price. It provides investors with insight into the return they can expect based on the current price of a bond, rather than its original purchase price or par value. This concept is especially important in bond pricing as it helps assess the attractiveness of a bond investment compared to others.

5 Must Know Facts For Your Next Test

1. Current yield is calculated by dividing the annual coupon payment by the current market price of the bond.
2. It offers a snapshot of an investor's return but does not account for other factors like capital gains or losses if the bond is held to maturity.
3. As market prices fluctuate, so does the current yield, making it a dynamic measure that reflects changing market conditions.
4. Current yield can help investors compare different bonds with varying prices and coupon rates, assisting them in making informed investment decisions.
5. A higher current yield may indicate a more attractive investment opportunity, but it could also signal increased risk associated with the bond.

Review Questions

• How does current yield provide insight into an investor's return compared to other metrics like coupon rate?
  • Current yield offers a more immediate perspective on potential returns by relating annual income directly to the bond's current market price. While coupon rate gives information based on the original face value, current yield adjusts for market fluctuations, making it crucial for evaluating how attractive a bond might be at its present price. This helps investors make comparisons among bonds with different characteristics, especially in volatile markets.
• In what ways does current yield influence investor decisions when assessing bonds in fluctuating markets?
  • Current yield significantly influences investor decisions by highlighting how changes in market price affect returns on investment. When market prices drop, current yields increase, potentially attracting investors seeking higher returns. Conversely, if prices rise, current yields decrease, which may lead investors to reconsider their options. This dynamic helps investors gauge relative attractiveness among various bonds and decide whether to buy, sell, or hold their investments based on current market conditions.
• Evaluate the implications of relying solely on current yield when considering bond investments versus incorporating other factors like yield to maturity and risk assessment.
  • Relying solely on current yield can provide a narrow view of an investment's potential returns, as it does not factor in aspects such as total returns from capital appreciation or depreciation. Additionally, it overlooks risks associated with individual bonds that may not be evident from current yield alone. By incorporating metrics like yield to maturity and conducting thorough risk assessments, investors can gain a more comprehensive understanding of their investment options. This multifaceted approach allows for better-informed decisions that align with overall investment goals and risk tolerance.

Related terms

coupon rate: The coupon rate is the annual interest rate paid by a bond issuer to bondholders, expressed as a percentage of the bond's face value.

yield to maturity (YTM): Yield to maturity is the total return expected on a bond if it is held until maturity, taking into account all coupon payments and the difference between the purchase price and par value.

market price: The market price is the current price at which a bond is trading in the market, which can fluctuate based on supply and demand dynamics.