Current Yield¶
Current Yield is a financial metric used to evaluate the annual return rate of a bond based on its current market price rather than its face value. This measure is particularly useful in the secondary market where bonds can be bought and sold at prices that differ from their initial face values.
Definition¶
Current Yield connects the annual income from bond interest payments to its price on the secondary market. It provides an immediate sense of the income return relative to the market price of the bond.
Formula¶
The formula to calculate Current Yield is:
\(Current\ Yield = \left(\frac{Annual\ Interest}{Current\ Market\ Price}\right) \times 100\)
Where:
- Annual Interest is the total interest payment received from the bond over one year.
- Current Market Price is the price at which the bond is currently selling on the secondary market.
Calculation Example¶
Consider a bond with a face value of Rs 100 and a coupon rate of 12%. If this bond is currently selling for Rs 80, the calculation would be:
- Annual Interest: 12% of Rs 100 = Rs 12
- Current Market Price: Rs 80
\(Current\ Yield = \left(\frac{12}{80}\right) \times 100 = 15%\)
Interpretation¶
- Current Yield > Coupon Rate: This scenario occurs when the bond is selling at a discount. In our example, the bond's coupon rate is 12%, but the Current Yield is 15%, indicating the bond is sold at a discount.
- Current Yield < Coupon Rate: This condition arises when the bond is selling at a premium. It means the market price of the bond is higher than the face value, reducing the yield relative to the coupon rate.
Significance of Current Yield¶
- Investor Insight: Provides bondholders and potential investors with an immediate understanding of what they can expect to earn in yield terms from the bond's current price.
- Market Fluctuations: Reflects how changes in the market price of the bond affect the yield, giving an indication of market perceptions and interest rate movements.
- Decision Making: Helps investors make informed decisions when buying or selling bonds in the secondary market, especially when comparing bonds with different coupon rates and market prices.
Conclusion¶
Understanding the Current Yield of a bond is crucial for investors aiming to maximize their returns from bond investments, particularly when operating in the secondary market. This measure gives a snapshot of the income-generating potential of a bond at its current market price, allowing for more strategic investment decisions based on immediate yield estimations.
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