What Is the Current Yield?
Let me explain current yield directly to you: it's the annual income from an investment, like interest or dividends, divided by the security's current price. For bonds, this looks at the current market price instead of the face value. It shows the return you'd expect if you bought the bond now and held it for a year. But remember, this isn't the actual return if you hold it to maturity.
Understanding Current Yield
In fixed income investing, current yield takes the annual income from interest and dividends and divides it by the security's current price. The market price of a bond can fluctuate, so you might buy it at a discount or premium, and that directly impacts the current yield. For stocks, you calculate it the same way: divide the dividends by the current market price. As a rule, expect higher returns from riskier investments, so if two bonds have similar risks, go for the one with the higher yield.
How Current Yield Is Calculated
Here's how you calculate it: if you buy a bond with a 6% coupon rate at a discount for $900, your annual interest is $60 (that's 6% of $1,000). The current yield is $60 divided by $900, which gives 6.67%. That $60 stays fixed no matter what you paid. But if you buy the same bond at a premium for $1,100, the yield drops to $60 divided by $1,100, or 5.45%. You paid more for the same interest, so the yield is lower. For stocks, it's straightforward: dividends divided by market price.
Factoring in Yield to Maturity
Yield to maturity, or YTM, is the total return if you hold the bond until it matures. Take that 6% bond bought for $900, maturing in 10 years. You get $60 annually for 10 years, then $1,000 at maturity, giving a $100 capital gain. To find YTM, discount those future payments to present value using an assumed rate. If bought at a premium, you'd factor in a capital loss at maturity. This gives a fuller picture than current yield alone.
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