Lesson

The current yield measures the income generated by a fixed-income security, such as a bond, relative to its current market price. It is calculated by dividing the annual interest payment by the bond's current market price.

Practice Question #1

What is the formula for calculating the current yield of a bond?

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Terms

Current Yield:
The annual income a bond generates relative to its current market price.

Practice Question #2

Which of the following factors does NOT affect the current yield of a bond?

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Do Not Confuse With

Nominal Yield:
The interest rate stated on a bond when issued, also known as the coupon rate or fixed rate of return.
Yield to Call:
The yield on a bond if it is called by the issuer before maturity.
Yield to Worst:
The lowest potential yield on a bond, considering all possible call or prepayment scenarios.

Practice Question #3

An investor compares two bonds with the same face value and maturity date. Bond A has a higher coupon rate than Bond B but trades at a higher market price. Which bond has a higher current yield?

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Historical Example

In the early 1980s, interest rates were at historically high levels, with the Federal Reserve raising rates to combat inflation. As a result, bond yields were also very high, with some long-term government bonds offering current yields of 15% or more. This made bonds an attractive investment option for income-seeking investors, as the high yields provided a significant income stream relative to the bonds' market prices.

Practice Question #4

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Real-World Example

Suppose an investor is considering purchasing a bond with a face value of $1,000, a coupon rate of 5%, and a current market price of $950. The annual interest payment on the bond would be $50 (5% of $1,000). The current yield on the bond would be 5.26% ($50 / $950), which represents the income generated by the bond relative to its current market price.

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Formulas to Remember

Current Yield = (Annual Interest Payment / Bond's Market Price) * 100

Practice Question #6

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Formula Examples

Suppose a bond has an annual interest payment of $50 and is trading at $1,000. To calculate the current yield: Current Yield = ($50 / $1,000) * 100 Current Yield = 0.05 * 100 Current Yield = 5%

Practice Question #7

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Pitfalls to Remember

Market Price Fluctuations:
The current yield calculation is based on the bond's market price, which can fluctuate over time. As a result, the current yield may not accurately represent the bond's long-term yield.
Not a Comprehensive Measure:
The current yield does not consider the bond's maturity, credit quality, or other factors that may affect the bond's overall return. It is only a snapshot of the bond's income-generating potential at a specific point in time.

Practice Question #8

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Practice Question #9

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