BIWS Platinum, Venture Capital, and Project Finance Course Prices Increasing on July 1st, 2024

×

Current Yield on a Bond: Definition, Examples, and Key Relationships

The Current Yield on a bond tells you the percentage return an investor can expect to earn over the next year if they purchase the bond at its current market price.

Current Yield Definition: The Current Yield on a bond tells you the percentage return an investor can expect to earn over the next year if they purchase the bond at its current market price.

A “bond” is a loan that a company takes out to borrow money; it must be repaid in full in the future, and the company must pay interest on it each year.

From the company’s perspective, the bond yield represents their borrowing costs; from an investor’s perspective, the bond yield represents the potential returns and the risks associated with the company’s issuance.

Core Financial Modeling

Learn accounting, 3-statement modeling, valuation/DCF analysis, M&A and merger models, and LBOs and leveraged buyout models with 10+ global case studies.

All bonds have coupon rates attached, which indicate the amount of interest the company must pay each year.

For example, a \$1,000 bond with an 8% coupon rate means the company must pay 8% * \$1,000 = \$80 in interest per year.

The Current Yield is different from the coupon rate because it factors in the market price of the bond – so, the investors could earn a return over the next year that’s higher or lower than the stated coupon rate.

For example, let’s say this same \$1,000 bond trades at a 10% discount, so its market price is \$900.

The annual coupon (interest payment) is still \$1,000 * 8% = \$80.

However, the Current Yield is \$80 / \$900 = 8.9%.

Investors can buy the bond at a discount, which means that their return over the next year will be higher than the stated 8% coupon rate.

Bonds usually trade at discounts or premiums due to changes in interest rates since they were issued, but factors such as the company’s credit quality can also factor in.

Current Yield Formula: How to Calculate the Current Yield

The formula for the Current Yield is:

If you do not know the bond’s current market price, you could estimate it with the PRICE function in Excel, but this requires inputs for variables such as the Discount Rate (i.e., the prevailing yields on similar bonds in the market).

And if you cannot find this one bond’s specific price, you probably won’t be able to get information on the yields for many other bonds in the market.

So, in reality, you normally have to look in a company’s filings and hope they disclose the current price (or use a paid service such as Bloomberg, which tracks bond prices):

This Current Yield calculation helps investors identify bonds that generate the highest returns, which can be helpful for short-term investments.

However, it is also a double-edged sword because bonds with higher returns also have greater risk – meaning there is a higher chance of losing money or selling the bond at a loss in the future.

Rules of Thumb for the Current Yield

Since the Current Yield is affected mostly by the bond’s market price and coupon rate, we can establish several key relationships based on these drivers.

“YTM” below is the “Yield to Maturity,” which represents the annualized return if you hold the bond until it matures and the company repays it in full:

1) Discount Bond (Market Price < Par Value): YTM > Current Yield > Coupon Rate

2) Premium Bond (Market Price > Par Value): Coupon Rate > Current Yield > YTM

3) Bond at Par (Market Price = Par Value): YTM = Current Yield = Coupon Rate

In the sections below, we’ll look at each scenario in detail and show the full numbers.

Current Yield Scenario #1: Discount Bond (Market Price < Par Value)

The assumptions here are as follows:

Bond Par Value: \$1,000 (The company issued it at this price)

Coupon Rate: 6%

Current Market Price: \$950

Current Yield = (6.0% * \$1,000) / \$950 = 6.3%

Since the bond trades at a discount to par value (market price < par value), its Current Yield of 6.3% exceeds its coupon rate of 6%:

Most likely, this bond trades at a discount because overall interest rates have risen since it was issued.

Therefore, its 6% coupon rate looks less appealing than it when it was first issued, so its price has fallen.

Current Yield Scenario #2: Premium Bond (Market Price > Par Value)

Conversely, if the bond trades at a premium to par value (market price > par value), its Current Yield is less than its coupon rate.

Here’s an example:

Bond Par Value: \$1,000 (Company issued it at this price)

Coupon Rate: 6%

Current Market Price: \$1,100

Current Yield = (6.0% * \$1,000) / \$1,100 = 5.5%

Since the bond trades at a premium to par value, its Current Yield of 5.5% is less than its coupon rate of 6%:

This bond likely trades at premium because overall interest rates have decreased since the initial issuance.

In other words, its 6% coupon rate now looks better than what investors could get from new bond issuances in this market, so its price has increased.

Current Yield Scenario #3: Bond at Par (Market Price = Par Value)

This example uses the same parameters, but assumes the bond’s market price equals its par value:

Bond Par Value: \$1,000 (Company issued it at this price)

Coupon Rate: 6%

Current Market Price: \$1,000

Current Yield = (6.0% * \$1,000) / \$1,000 = 6.0%

Since the bond price is equal to its par value, its Current Yield of 6.0% is the same as its coupon rate:

It’s fairly rare for a bond’s market price to equal its par value exactly, but it does happen sometimes.

This scenario is the most common with investment-grade or “blue chip” companies that have very low credit risk and that have recently issued bonds in an environment in which interest rates have not changed significantly.

Current Yield vs. Yield to Maturity vs. Yield to Call vs. Yield to Worst

These yield metrics all measure the returns an investor can expect to receive on a bond, but they do it in different ways.

Current Yield: This tells you the percentage investors would earn on a bond if they bought it today and held it for a year, factoring in the market price and the coupon rate on the bond.

Yield to Maturity: This gives the annualized return investors earn if they buy a bond at its current market price and hold it until maturity, assuming the company makes all the required payments and the investor reinvests the interest payments at the same rate as the overall return.

Yield to Call: This is similar to the YTM, but investors hold the bond only until an earlier call date, not the maturity date, and also receive some type of penalty fee paid by the company in exchange for this early repayment.

Yield to Worst: This is the lowest annualized return an investor might receive from buying and holding a bond until either early repayment or maturity, i.e., it is the minimum of all the YTCs and the YTM.