A current yield is a financial metric used to measure the income generated by an investment option, most usually a bond, relative to its current market price. It is calculated by dividing the annual income on investment by the security’s current market price. Thus, a current yield is a quick snapshot of what returns an investor can expect from a financial investment.
Continue reading and explore more about current yield, how it’s calculated and the factors that affect it.
Understanding the Calculation of Current Yield With an Example
An investor invests in a bond of face value of $1000 with a coupon rate of 5%. The current market value of the bond is $900. So, the current yield will be calculated as follows:
Current yield= Annual income on an investment ÷ current market value
Current yield= ($1000 x 5%) ÷ $900
That is equal to ($50) ÷ $ 900 = 0.0556
Now, this is represented in a percentage form, which makes the current yield on the investment 5.56%.
Explore the Key Factors that Affect the Current Yield
Although the calculation of the current yield is quite straightforward, there are several factors that affect this finance metric:
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Type of Security
The type of security investors invest in has a significant impact on the current yield. Generally, bonds have higher current yield compared to stock, as they offer fixed income over a specific period of time. However, other factors, like current market forces, maturity period and credit rating of a bond issuer, also affect the current yield.
For example, if the credit ratings are low, the risk of default is high, and thus, the current yield will be high to compensate the investors for added risk.
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Rate of Interest
The rise and fall in interest rates have a considerable impact on the current yield. For example, if the interest rates rise, the market value of the existing bonds declines, as investors are more inclined towards purchasing new bonds with higher interest rates. Now, this causes the current yield to go up.
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Market Conditions
The prevailing market conditions, like the level of inflation, also affect the current yields on securities. For example, during periods of financial uncertainty or high inflation in the economy, investors demand higher yields for taking an added investment risk. It thus leads to lower bond prices and higher current yields.
Conversely, when the market conditions and inflation levels are stable, investors are ready to accept lower yields due to lower risk associated with their investments.
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Re-investment Risk
The re-investment risk proceeds from the securities need to be re-invested at a lower yield. For example, if an investor purchases a bond at a 4% yield and the interest rates fall to 3%, then the investor may have to re-invest the proceeds at a lower yield, i.e. 3% instead of 4%. It can lead to a fall in the overall returns on investment.
Wrapping Up!
A current yield is a crucial finance metric to determine the potential return on investment, most generally, bonds. Thus, when making investment decisions, it is important to consider the current yield and the diverse factors that affect it. It helps in assessing the potential returns and risks associated with your financial investment.
Learn more about current yield with GoldenPi and start streamlining your investment decisions today!
FAQs About What is Current Yield?
1. Is the current yield affected by the bond’s maturity date?
The maturity date of a bond has a significant impact on its current yield. Usually, bonds with longer maturity periods offer higher current yields compared to those with shorter maturities. This is because investors demand higher yields for tying up their money in the investment option for a longer duration of time.
2. How is the current yield calculated on stocks?
When it comes to stocks or equities, the current yield is calculated by dividing the dividend received on the stock by its current market price. It helps investors draw a figure for the potential returns that they might expect from their investments.
3. How often does the current yield change?
The current yield is subject to the current market price of the security. Thus, if the current market value changes, the current yields will also change for a given financial security.
