The amount of interest you receive on a bond purchase does not change. Yield is merely a function of a bond’s market price, not its coupon rate, which is its interest rate based on the par value of the bond. If you buy that bond for $1,000, that pays $20 interest annually, but its market value increases to $1,100 one month later, then its current yield would decline from 2% when you bought the bond to 1.8%. Your bond would still pay $20 per year in interest, but since its value increased, its current yield would decline. Similarly, if the same bond declined in value, it’s current yield would increase. If the bond’s value declined to $900, the interest of $20 per year would be 2.2% of the market value, up from the 2% coupon rate when you first bought the bond. If you buy the same bond at a discount for $900, the bond still pays $20 interest each year. However, because you bought the bond for a price less than its par value, the current yield increases to 2.2%.
How Current Yield Works
Knowing a bond’s coupon yield and current yield can help you anticipate your return on investment. Let’s take a look at the math to calculate current yield. Again, if you receive $20 in annual interest on a bond with a par value of $1,000, the coupon rate is 2%. $20 / $1,000 = 0.02 X 100 = 2% As the market price of the bond changes, you divide the same interest payment by the current market value to get the bond’s current yield. So if the same bond increased in value to $1,100, it’s current yield would decline to 1.8%. $20 / $1,100 = 0.018 X 100 = 1.8% Similarly, if that bond’s market value declined to $90, it’s current yield would increase to 2.2%. $20 / $900 = 0.022 X 100 = 2.2%
What Current Yield Means for Individual Investors
Investors can use current yield, along with other types of yields, to help determine their expected return on the bond, so they can decide whether to include it in their portfolio. An investor can compare current yields against expected income from other assets such as other bonds or dividend stocks. While yields are important to consider when choosing assets, investors must consider a range of factors about their personal situation, including their risk tolerance and investing horizon. Similarly, you could calculate the current yield of a dividend stock by dividing the stock’s annual dividend payment by the market value of one of its shares. Keep in mind that with bonds, the annual interest payments remain fixed, but income from other assets, such as real estate or dividend stocks, can change.
