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Current Yield



Definition

Current yield refers to the annual income (interest or dividends) divided by the current price of the security. This term is mostly used in reference to bonds or other fixed-income securities. Essentially, it measures the return on investment an investor would receive if they bought a security at its current market price.

Phonetic

The phonetics of the keyword “Current Yield” is: /ˈkʌrənt jild/

Key Takeaways

  1. Current Yield Calculation: The current yield of a bond is calculated by dividing the annual amount of interest paid by the bond’s current market price. It shows the annual return on the face value of the investment.
  2. Current Yield vs. Yield to Maturity: Unlike Yield to Maturity (YTM), which takes into account both the current income received annually and any gain or loss the investor would incur if he holds the bond until maturity, current yield only takes into account income from interest payments, making it simple but less accurate reflection of overall return.
  3. Usefulness of Current Yield: The current yield is helpful in comparing the cash return rate of bonds versus other income-producing investments. For investors looking for immediate income, a high current yield may be desirable, however, they must also consider other factors like the creditworthiness of the issuer and the length of time to maturity.

Importance

The term “Current Yield” is significant in business/finance because it is used to assess the profitability of investments, particularly those related to bonds. The current yield shows the return on the original investment, in percentage terms, considering the annual income generated by the investment relative to its current market price. Hence, it’s a key measure used by investors to analyze the return on their investments, and to evaluate and compare the performance of different investments. Therefore, understanding the concept of current yield can guide investors to make more informed investment choices and achieve their financial objectives more effectively.

Explanation

The current yield is an essential financial metric that investors use to evaluate the efficiency of an investment, particularly in the bond market, though it applies to other types of investments as well. It refers to the annual income (interest or dividends) generated by an investment, expressed as a percentage of its current market price. This proportion serves as a snapshot of the income an investment provides relative to its value in the market. When used in the context of bonds, it helps investors understand the return they can anticipate from the bond’s interest payments relative to its current price, which may differ from its face value. While the concept of current yield seems straightforward, it is worth mentioning that it doesn’t take into account potential future changes in income or market value. This is important because while the current yield can provide a simplified look at an investment’s income-generating potential, the actual financial performance of a security is influenced by many factors beyond its current income and price. Therefore, the current yield should be used in conjunction with other financial metrics to give investors a more comprehensive picture of investment performance. It is especially useful to help compare different investments or to assess whether an existing investment continues to meet income goals.

Examples

1. Bonds: One of the primary uses of the term “current yield” is in bond investing. For instance, if an investor purchases a $1,000 face value bond with a 5% coupon rate, the bond is initially expected to release an annual income of $50. However, if market conditions change and the bond’s price decreases to $950, the current yield will increase to approximately 5.26% ($50 / $950). Despite the bond’s fixed income, the yield has changed due to the change in market price. 2. Dividend Stocks: When investing in dividend-paying stocks, current yield is a key measure. Suppose an investor buys shares in a company at $30 per share and the company pays annual dividends of $1.5 per share. The current yield would be 5% ($1.5 / $30). If the market price of the shares dips to $25, the current yield would increase to 6% ($1.5 / $25), suggesting a better return on the investment, despite no change in the absolute dividend payment. 3. Real Estate Investment Trusts (REITs): REITs often provide investors with dividends. The current yield can be determined by dividing the annual dividend income by the current market price of the REIT. For example, suppose an investor buys shares in a REIT at a price of $100 per share and receives $5 per share per annum as dividends. The current yield is 5% ($5 / $100). If the market price for the REIT shares grows to $120, the current yield would decrease to approximately 4.17% ($5 / $120), reflecting a lower return on investment relative to the market price.

Frequently Asked Questions(FAQ)

What is Current Yield?
Current Yield is a financial term that refers to the annual income that an investment provides relative to its market price. It is usually expressed as a percentage.
How is Current Yield calculated?
The Current Yield is calculated by dividing the annual income earned from an investment by the current market price of that investment.
Why is Current Yield important in finance?
Current Yield is an indicator of an investment’s rate of return, giving investors an implication of what they will earn in relation to the price of the investment. It is most often used in bond investing to determine the yield that a bond currently provides in comparison to its market price.
Does Current Yield consider the overall gain or loss of an investment?
No, Current Yield only considers the income generated from the investment, not any capital gain or loss.
How does Current Yield differ from Yield to Maturity (YTM)?
Current Yield only considers the annual interest income, whereas Yield to Maturity takes into account both the annual interest income and any capital gain or loss that would be realized if the bond was held until maturity.
What affects the Current Yield?
Current Yield can be influenced by changes in the market price of the investment. If the market price drops, the Current Yield will increase and vice versa.
Is a higher Current Yield always better?
Not necessarily. A higher Current Yield might indicate a higher return on an investment, but it could also suggest higher risk or volatility. Therefore, the Current Yield should not be the sole factor considered when making an investment.
Can Current Yield be negative?
Theoretically, yes. If the income generated from an investment is negative, then the Current Yield could be negative as well. However, this is extremely rare in traditional investments.

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