Current Yield: Definition, Formula, and Calculation Guide

Comprehensive overview of current yield, including its definition, formula, methods of calculation, and practical examples. Learn how current yield is used in investing and finance.

Current yield is the annual income from an investment, normally in the form of interest or dividends, divided by the current market price of the security. It provides investors with a snapshot of the return on investment they can expect if they purchase the security at its current price.

Formula

The formula for calculating current yield is:

$$ \text{Current Yield} = \frac{\text{Annual Income}}{\text{Current Price}} $$

Where:

• Annual Income refers to the total interest or dividends received in a year.
• Current Price is the trading price of the security on the open market.

Types and Variations

Bond Yields

For bonds, the annual income is the coupon payment, and the formula simplifies to:

$$ \text{Current Yield} = \frac{\text{Annual Coupon Payment}}{\text{Current Bond Price}} $$

Stock Yields

For stocks, the annual income is the total dividends paid, and the formula is:

$$ \text{Current Yield} = \frac{\text{Annual Dividends per Share}}{\text{Current Stock Price per Share}} $$

Calculating Current Yield: Step-by-Step Guide

To calculate the current yield, follow these steps:

• Determine Annual Income: Find the annual coupon payment for bonds or the total annual dividends for stocks.
• Identify Current Price: Check the current market price of the security.
• Apply the Formula: Divide the annual income by the current price.

Example Calculation

For a Bond:
Suppose a bond has an annual coupon payment of $50 and the current market price is $1,000.

$$ \text{Current Yield} = \frac{50}{1000} = 0.05 \text{ or } 5\% $$

For a Stock:
Assume a stock pays annual dividends of $2 per share, and its current market price is $40 per share.

$$ \text{Current Yield} = \frac{2}{40} = 0.05 \text{ or } 5\% $$

Historical Context and Applicability

Current yield has been a vital metric in investment analysis since the inception of financial markets. It allows investors to compare the profitability of different securities easily. It’s particularly crucial for fixed-income investors and dividend-focused equity investors.

Comparisons

Current Yield vs. Yield to Maturity

• Current Yield: Only takes into account annual income and current price.
• Yield to Maturity (YTM): Considers all future coupon payments and capital gains or losses until maturity.

Current Yield vs. Dividend Yield

• Current Yield (for stocks): Reflects the current income compared to current price.
• Dividend Yield: More specific to dividend-paying equities and is calculated similarly but also considers future potential dividends.

FAQs

Q1: Is it possible for the current yield to change?
A: Yes, it changes with fluctuations in the market price of the security.

Q2: Is a higher current yield always better?
A: Not necessarily, as it may indicate a higher risk or underperformance by the underlying security.

Q3: How does current yield differ for bonds and stocks?
A: For bonds, it is based on coupon payments, while for stocks, it is based on dividend payments.

Summary

Current yield is a fundamental metric in evaluating the return on investment for different securities. Whether it is for bonds or stocks, understanding how to calculate and interpret current yield can guide investors in making informed financial decisions. By considering both income and current price, it provides an immediate perspective on investment profitability.

References

1. Fabozzi, F. J. (2005). The Handbook of Fixed Income Securities.
2. Bodie, Z., Kane, A., & Marcus, A. J. (2021). Essentials of Investments.