Definition
The term current yield refers to a calculation that determines the annual return provided to an investor purchasing a bond or dividend paying stock. Current yield is determined using the security's coupon or dividend rate and its current market price.
Calculation
Current Yield (%) = (Annual Payments / Market Price) x 100
Where:
Annual Payments are equal to the total of all the bond or dividend payments received over the next twelve months.
Market Price is the current market price of the security; not the price when the security is first issued or purchased by the investor.
Explanation
Also known as the interest yield, market yield and running yield, the current yield is the annual rate of return received by the investor based on the security's current market price. While the term oftentimes refers to bonds, the same concept applies to dividend paying stocks. The current yield on a security represents the return the investor would realize if they held the security for one year.
The calculation does not account for changes in the security's value over time when held by the investor. An investor would look to another measure, such as yield to maturity, if they wanted to understand the bond's yield if held until it matures. For the same reason, a bond's coupon rate is only relevant when the security is sold at par value, which rarely happens.
Two general rules apply when comparing the bond's current yield to its coupon rate:
If the current market price is less than the bond's par value, then its current yield will be greater than its coupon rate.
If the current market price is greater than the bond's par value, then its current yield will be less than its coupon rate.
When making a purchase decision, the investor should also consider the issuer's risk of non-payment. Generally, securities with higher risk of non-payment provide investors with higher returns.
Note: Zero coupon bonds do not pay periodic interest, instead they are sold at a discount and increase in value on the secondary market as they approach maturity. At maturity, the holder would receive the par value of the bond.
Example
Company ABC issued a bond with a par value of $1,000, which pays a $35.00 coupon twice per year. If the holder paid $900 for the bond, the current yield would be:
= (($35.00 x 2) / $900) x 100= ($70.00 / $900) x 100, or 7.78%
