Current Yield

Current Yield is a handy little metric that tells you the annual income an investment, typically a bond, generates as a percentage of its current market price. Think of it as a snapshot of your immediate return from interest payments alone. It’s calculated with a simple formula: Annual Cash Inflow / Current Market Price. For bonds, this translates to the annual coupon payment divided by the bond's current price on the market. For instance, if you buy a bond for $950 and it pays $50 in interest per year, your current yield is about 5.26% ($50 / $950). This figure is a moving target because while the annual interest payment is usually fixed, the market price of the bond wiggles up and down. It's a quick and useful gauge, but as we'll see, it doesn't tell the whole story of a bond's total return.

Imagine a 'Capipedia Corp.' bond with a par value (or face value) of $1,000 and a coupon rate of 5%. This means it was issued with a promise to pay the bondholder $50 in interest each year (5% x $1,000). Now, let's say the economy gets a bit rocky, and the market price of this bond drops to $950. If you buy it at this price, your coupon payment is still a fixed $50. Your Current Yield is: $50 / $950 = 0.0526, or 5.26% Even though the coupon rate is 5%, your current yield is higher because you bought the bond at a discount. You're getting the same $50 income stream for a smaller upfront investment.

It's easy to mix these up, but the difference is vital. The Coupon Rate is fixed for the life of the bond; it’s calculated off the bond’s original face value and never changes. The Current Yield, however, is dynamic. It moves in the opposite direction of the bond’s price.

• If a bond's price falls below its face value (it's trading at a 'discount'), the current yield rises above the coupon rate.
• If a bond's price rises above its face value (it's trading at a 'premium'), the current yield falls below the coupon rate.
• If a bond's price is exactly its face value, the current yield and coupon rate will be the same.

For a value investor, Current Yield is a useful starting point but a poor finishing line. It provides a quick answer to the question: 'What is this bond paying me right now relative to its cost?' It’s a measure of immediate income potential. However, its simplicity is also its biggest weakness. It completely ignores two crucial factors:

• The Payday at the End: It doesn't account for the capital gain you'll make if you buy a bond at a discount (like our $950 example) and hold it until it matures and you get the full $1,000 face value back. Nor does it account for the potential capital loss if you bought it at a premium.
• The Power of Time: It doesn't factor in when those payments are received, treating a dollar today the same as a dollar in ten years.

If Current Yield is a quick snapshot, then Yield to Maturity (YTM) is the full movie. YTM is the total anticipated return an investor can expect if they hold the bond until it matures. It accounts for everything: the price you paid, all future coupon payments, the final repayment of the face value, and the time remaining until maturity. While calculating YTM is more complex (you'll likely need a financial calculator or software), it provides a far more accurate picture of a bond's true profitability over its lifetime. A savvy value investor uses Current Yield for a quick assessment but always relies on YTM for the final investment decision.

The concept of current yield has a close cousin in the world of equities: the dividend yield. For a stock, you would calculate this by taking the annual dividend per share and dividing it by the stock's current market price. Both metrics give you a sense of the income-generating power of an asset based on its current price, which is always a useful piece of the puzzle for an investor.