Yield Measures: Current Yield and Simple Yield
Sometimes you just want a quick yield estimate without doing a lot of math.
That's really what the __current yield__ is. It's very simple and fairly inaccurate. Just divide the coupon payments due in a calendar year and divide this sum by the current price of the bond. That's it! So, a bond that pays a 4% coupon and is trading at par has a current yield of 4/100 = 4%.
Suppose James, an investor, has a $1,000 bond with nine years until maturity, which has a 5.5% semiannual pay coupon. The bond is currently trading at a premium of 101.2. What would you estimate for the current yield?
No.
This figure uses just a single coupon payment, but the current yield calculates the annual coupon payments, so both coupons of $27.50 should be included.
That's right!
The bond pays coupons of 5.5%/2 x $1,000 = $27.50 every six months. The current yield is then the $55 annual coupons divided by the current price of $1,012, or close to 5.43%.
Alternatively, you could just divide the coupon rate of 5.5% as a percentage by the quoted price of 101.2 for the current yield.
$$\displaystyle \frac{5.5}{101.2} \approx 0.0543 = 5.43 \% $$
No.
It's possible that this figure was obtained by assuming that the 5.5% coupon is paid every six months, but the coupon rate is an annual rate already.
As the bond approaches maturity, the price will fall below 101. What will happen to the current yield?
No, it will change.
The current yield uses the current price of the bond, so if the price changes, the current yield changes.
No.
Think about the ratio of the current yield and what will happen with a lower denominator.
Exactly!
The current yield of 5.44% is going to rise as that premium price of 101.2 falls below 101 on its way to par, given that the coupon payments will remain constant throughout the bond's tenor.
And what would you estimate the current yield to be for a zero-coupon bond with a yield to maturity of 8.2%?
To summarize this discussion:
[[summary]]
No.
The yield is still just the annual coupons divided by price. Very little information is given here, but it's enough.
No.
The current yield in this case is far from the yield to maturity. Use the same simple ratio as before.
Absolutely!
No coupon equals no current yield.
This highlights the inaccuracy of the current yield. Without accounting for all cash flows, it's certainly not a good measure to use for holding a bond until maturity.
One last, obscure yield measure is the __simple yield__. The simple yield is the sum of the coupon payments plus the straight-line amortized share of the gain or loss, divided by the flat price. There's not even a single numerical example in the curriculum, so it's probably safe to assume that it won't be on the exam.
2.72%
5.43%
10.87%
It won't change
It will fall
It will rise
Zero
About 4%
About 8%
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