What is the Current Yield formula?

The current yield is the annual return of a bond based on the annual coupon payment and current bond price (vs its original price or face).

The current yield formula takes into consideration the current price of the bond instead of the face value of the bond. It represents the investor’s expected return instead of the actual return, if the owner purchased and held the bond for a one year period. 

Current\space Yield\space = \frac{Annual\space Coupons} {Current\space Bond\space Price}

There are a number of formulas that are available to calculate the yields on bonds. However, as the name implies, the current yield formula calculated the ‘current’ or ‘present’ annual yield on coupons. On the contrary, the bond yield formula calculates the yield against the face value or original price of bond.

How to calculate the current yield formula?

For example, assume an investor buys a bond with 6 % coupon rate at a discount of $9,000. The investor earns interest income of $60 ($1,000 x 6 %). The current yield (annual cash inflow / market price), in this case, comes out to be 6.67% ($60/$900).  Regardless of the price paid for the bond, $60 is the annual interest that the investor will earn.

For instance, the investor buys the bond at premium for a price of $11,000. In this case, the current yield of the investor will be 5.45 % ($60 / $1,100). The current yield of the investor is lower in this case because, the investor paid a higher price for the premium.

In case of stocks, the current yield can be calculated by dividing the annual dividends received divided the current market price of the stock.

Uses of Current yield formula in Finance

The current yield formula is often used in the bond investments that are securities which are issued to investors at face amount or par value of $1,000. The bond carries a coupon rate which is stated on the bond certificate that may be traded between investors. The market price of the bond can increase or decrease, therefore, the investor can buy the bond at discount (price lower than the par value) or at a premium (price more than the par value). The price of the bond inversely affects the current yield on the bond.

Alternative uses of current yield formula

The current yield formula can be used with other formulas such as the yield to maturity, bond yield formula, yield to call etc. to calculate and the returns of different bonds.

The current yield formula can also be applied with the risk ratings as well as in comparison of different bonds. As a common rule in theory of Finance, a riskier bond is compensated with a higher return or premium. If the risk is assumed to be same for two bonds, the bond with higher return shall be preferred.

Difference with Yield to Maturity

The current yield is different from the yield to maturity because the yield to maturity takes into consideration all the future yields from the bond, till its maturity. The yield to maturity is total return or yields the investor receives on the bond.

The yield to maturity determines the yield on the present value basis. Contrarily, the current yield only considers the one year coupon rate and the current price of the bond. In calculating the yield to maturity, investor has to assume that the bond owner holds the bond till maturity and the interest rate per year.

How Yield To Maturity is calculated?

For example, there is a purchase of bond with the coupon rate of 6% at $900 with maturity period of 10 years. In this example, when the YTM of the bond is calculated, investor recognizes a capital gain or capital loss as the price of the bond increases and decreases at maturity.