How to Calculate Current Yield

In the world of investing, understanding the various metrics that reflect an asset's performance is crucial to making informed decisions. One such metric for evaluating bonds is the current yield.

The current yield is simply the bond's annual interest payment as a percentage of the current bond price. It can be calculated as follows:

Formula:
Current yield = Coupon payment / Current bond price
Or,
Current Yield = Annual Interest Payment / Current Market Price of Bond
Note: if the market price for the bond is equal to its face value, then the current yield will be the same as nominal yield.

Example 1:
a bond with a coupon yield of 5.5 percent trading at 105 ($1,050) will have a coupon payment of: 5.5% * $1,000 = $55, and a current yield of: 55 / 1050 = 5.24%.

Example 2:
Suppose that a bond with a coupon rate of 6% is selling at $800 ($200 below its issue price of $1,000). Then:
The annual interest payment = 6% * $1,000 = $60
The current yield = 60 / 800 = 7.5%

The Role of Current Yield in Bond Investment

The current yield provides a snapshot of a bond's income-generating potential at a given time. It is an especially important metric for income-focused investors who are looking for a steady cash flow from their investments. Bonds, particularly government and corporate bonds, are often purchased by investors who seek consistent income over time, and the current yield allows them to quickly compare different bond investments.

Significance of Current Yield

The current yield is an important metric for bond investors because it provides insight into the income return on a bond relative to its current price in the market. This is particularly useful for:

Comparing Bonds: The current yield allows investors to compare different bonds with varying prices and coupon rates. For example, if two bonds have similar coupon rates but one is priced higher than the other, the bond priced lower will generally have a higher current yield. This can help investors identify which bond offers a more attractive return relative to its price.

Income Assessment: For income-focused investors, the current yield gives a quick estimate of the return they can expect to earn from the bond’s interest payments at its current market price. This is especially relevant for fixed-income investors who rely on bond yields to generate regular income.

Price Sensitivity: The current yield reflects the market's perception of the bond’s value based on interest rate movements. If interest rates rise, the price of existing bonds tends to fall, leading to a higher current yield. Conversely, if interest rates fall, bond prices rise, which lowers the current yield. Investors can use this information to gauge how price changes might affect their bond income.

Investment Strategy: The current yield can also inform an investor’s strategy. For example, if an investor is seeking bonds with high current yields, they may be willing to accept bonds with lower credit ratings or longer durations in exchange for higher income.