How to Calculate a Bond's Current Yield
When investors purchase bonds, they do so primarily to generate income. The expected annual rate of return is called the current yield, and it is a function of the current price and the amount of interest the bond pays. However, bonds issued by governments and corporations are bought and sold on the bond market. This means that prices change. Investors need to understand the relationship between price and yield, as well as learning how to determine current yield.
Understanding the Coupon Rate
Corporations and governments at all levels frequently borrow funds by selling bonds. Each bond pays a fixed sum of money each year called the coupon. Usually, this is expressed as a percentage of the bond's face value, called the coupon rate. For example, a bond with a $1,000 face value and a $50 coupon has a coupon rate of 5 percent.
Bond Yield Vs the Coupon Rate
When bonds are originally issued, they usually sell at or near the face value, so the coupon rate is essentially the rate of return the investor can expect. However, if a bond is purchased later on the secondary market, typically, the price is different, and this means the yield is also different. For instance, if you buy a bond that has a face value of $1,000, with a $50 coupon for $800, the actual interest rate or yield is 6.25 percent.
Inverse Price/ Yield Relationship
The price and yield of a bond vary inversely. That is, when the price goes down, the yield goes up, and when the price goes up, the yield declines. The current yield is simply the yield you'd get if you buy a bond at the current market price. Although simple, current yield is a critical measure, because it defines the rate of return on your investment for as long as you own the bond.
Finding a Bond Price
Before you can calculate current yield, you must determine the current price. Investors new to bonds may be confused by the way prices are quoted. This is because the price is listed as a percentage of the face value, and not as a dollar amount. For example, a $5,000 face value bond with a current price of $4,500 will be quoted at 90 percent.
Determining the dollar value of a bond price quote is not difficult. Multiply the face value of the bond by the quoted percentage. Suppose a $5,000 bond is quoted at 85.0 percent. Multiply 85 percent by $5,000 to compute the dollar value of $4,250.
Calculating Current Yield
After you determine the current price of a bond, calculating its current yield is straightforward. The current yield is equal to the annual interest earned divided by the current price of the bond. Suppose a bond has a current price of $4,000 and a coupon of $300. Divide $300 by $4,000, which equals 0.075. Multiply 0.075 by 100 to state the current yield as 7.5 percent.
Based in Atlanta, Georgia, William Adkins has been writing professionally since 2008. He writes about small business, finance and economics issues for publishers like Chron Small Business and Bizfluent.com. Adkins holds master's degrees in history of business and labor and in sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.