What Is Current Yield?
Current yield is a bond's annual coupon divided by its current market price, expressed as a percentage. It is the simplest yield measure and the least complete, because it ignores the maturity date entirely and says nothing about whether you get your capital back.
Current yield is the easiest bond number to calculate and the easiest to be misled by. It answers one question — what income am I getting for what I paid — and stays silent on the question that decides the outcome.
How it works
Annual coupon divided by current price. A bond paying 5 a year, trading at 100, has a current yield of 5%. The same bond at 80 has a current yield of 6.25%.
The maturity date does not enter the calculation. A bond with six months left and one with thirty years left, both paying 5 and both trading at 80, have identical current yields and completely different prospects.
So a rising current yield is usually a falling price. The coupon is contractual and changes almost never. Essentially all day-to-day movement in the figure is the denominator.
A worked example
Two bonds, both paying a 5 coupon, both trading at 80.
Bond A matures next year at 100. You collect 5 of income and 20 of capital gain within twelve months.
Bond B matures in thirty years. You collect 5 a year and wait three decades for the 20.
Current yield reports 6.25% for both. Yield to maturity, which counts the capital return and when it arrives, separates them enormously — and it is the number that describes what actually happens.
The reverse case is worse. A bond bought at 110 that redeems at 100 has a built-in 10-point capital loss built into it. Current yield reports only the income and will show an attractive figure right up until redemption takes the difference back.
The two measures agree at exactly one price: par. Anywhere else they diverge, and the direction of the divergence tells you whether the capital movement is helping or hurting.
The same trap as dividend yield
A high current yield is often a warning rather than an offer. The mechanism is identical to dividend yield: price in the denominator, a fixed payment on top, and a screener that sorts by the result is sorting by which prices have fallen furthest.
In bonds the fall usually means credit doubt. The market has concluded the coupon may not keep arriving, and the yield rose because of that conclusion rather than in spite of it.
When it is the right number
It has one honest use: comparing income against what you paid. If the reason for owning the bond is the cash arriving each year, current yield answers that question directly and no other measure does it as cleanly.
It also works well for bonds close to par, where the capital movement at redemption is small enough not to distort the picture.
And it is the right figure for a perpetual bond, which has no maturity date, so there is no capital return to account for and yield to maturity has nothing to calculate.
Everywhere else it is a partial answer. The rule that holds is simple: the further a bond’s price sits from face value, the more current yield misleads, and the direction of the error is always toward flattering the bond. Below par it understates the return; above par it overstates it. Neither error announces itself on the screen.
The original data
Use this site’s thirty-year fee measurement for scale: 5 basis points a year costs 1.5% of the final balance, 20 costs 5.8%, 75 costs 20.2%, 150 costs 36.5%.
Now price the gap between the two yield measures. A bond bought at 110 redeeming at 100 in ten years carries about a point a year of capital loss the current-yield figure never mentions — 100 basis points, which sits near the bottom of that fee table for annual damage and is invisible on the screen showing the yield.
And costs come out before any of it. A round trip on this site’s shared series is 0.0098, about 2% of the median bar range of 0.493 — small per trade and repeated on every reinvestment.
One more place it misleads: a bond approaching maturity. As redemption nears, a bond trading away from par converges toward face value regardless of anything else, so the capital movement accelerates while the current yield carries on reporting the same ratio. The closer the date, the more of the real return sits in a number this measure does not contain.
When it fails
The characteristic failure is buying the highest current yield on a list. The screen sorts by a ratio whose denominator is a falling price, so the top of the list is the bonds the market trusts least, ranked by how little it trusts them. The income looks generous, the capital position is not examined, and the outcome is decided by whether the issuer keeps paying — a question the figure was never capable of answering.
A second failure is comparing bonds of different maturities on it, which is comparing two different questions and reading one answer.
A third is ignoring a premium price. Above par, part of what looks like income is capital being returned to you.
A fourth is using it for a bond fund, which has no maturity date at all, so the capital half of the question never resolves.
And a fifth is treating it as the yield. There are at least three, they disagree, and only one of them describes the outcome of holding to the end.
Related
Yield to maturity covers the fuller measure including the capital return. Coupon yield covers the fixed payment in the numerator. And dividend yield covers the identical trap in equities.
Current yield is the bond equivalent of dividend yield, and it carries exactly the same trap: the denominator moves every day and the numerator moves once a decade, so almost everything you see in the figure is the price falling rather than the income improving.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.