Bonds are debt instruments where an issuer borrows money from investors and promises to repay the principal (face value) on a specific maturity date, along with periodic interest payments called coupon payments. The Yield of a bond is a measure of the return an investor can expect to receive on their investment. Unlike the coupon rate, which is fixed, the yield fluctuates based on the bond's market price.
The most common type of yield calculated for bonds is the Current Yield. This metric provides a simple way to understand the income an investor receives relative to the bond's current market price. It's particularly useful for comparing income generation from different bonds.
How Current Yield is Calculated
The Current Yield is calculated using the following formula:
Current Yield = (Annual Coupon Payment / Current Market Price) * 100%
To use this formula, we first need to determine the Annual Coupon Payment:
Current Market Price: The price at which the bond is currently trading in the market. This can be at par (equal to face value), at a discount (below face value), or at a premium (above face value).
Face Value (Par Value): The principal amount of the bond that will be repaid to the bondholder at maturity. Most commonly $100 or $1,000.
Annual Coupon Rate: The stated interest rate on the bond, expressed as a percentage of the face value. This rate determines the fixed annual interest payment.
Why is Bond Yield Important?
The yield is a critical factor for investors because it represents the actual return on their investment. When a bond's price rises above its face value (trading at a premium), its current yield typically falls below the coupon rate. Conversely, when a bond's price falls below its face value (trading at a discount), its current yield rises above the coupon rate. Understanding current yield helps investors make informed decisions about whether a bond offers an attractive return compared to other investment opportunities and its own coupon rate.
This calculator focuses on the Current Yield. Other yield measures, such as Yield to Maturity (YTM), take into account the time to maturity and reinvestment of coupon payments, providing a more comprehensive picture of a bond's total return, but are more complex to calculate.
Example Calculation
Let's consider a bond with the following characteristics: