What is the Current Yield?
How Does the Current Yield Work?
The formula for current yield is defined as follows:
CY = Annual interest payment / CurrentPrice
For example, let's assume a particular bond is trading at par, or 100 cents on the dollar, and that it pays a coupon rate of 3%. In this case, the bond's current yield will also be 3% (as shown below).
CY = 3 / 100 = 3.00%
However, let's now assume that the same bond is trading at a discount to its par value. For the sake of example, let's say investors can now purchase the bond for just 95 cents on the dollar. In this case, even though the bond will still be paying a 3% coupon, its current yield will actually be slightly higher (as shown below):
CY = 3 / 95 = 3.16%
As another example, let's say the bond is trading at a premium to its face value -- 110 cents on the dollar. In this case, even though the bond will still be paying a 3% coupon, its current yield will actually be quite a bit lower (as shown below):
CY = 3 / 110 = 2.73%
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Why Does the Current Yield Matter?
The important thing to note here is that for most bonds, the stated coupon rate will usually remain the same (in this case, 3%). However, as the prevailing level of interest rates changes over time, the return that investors will require (the current yield) in order to hold a specific bond will fluctuate. As a result, investors will send bond prices higher or lower until the current yield on that bond is equivalent to other securities with similar risk profiles.
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