Last month we looked at yield to maturity (YTM) as a way of measuring yields. This month we look at the other main yield measurement – the current yield.
Current Yield
The current yield measurement is also known as the running yield, flat yield and income yield. It is calculated by dividing the income received per annum (ie annual coupon of interest payments) by the purchase price of the investment excluding any accrued interest. Therefore, unlike the YTM measurement, it does not take into account any capital gained or lost on redemption/sale.
Expressed as an equation, the current yield is: \(CY=\:\frac{R}{P}*100\)
Where:
- \(CY\:= \:current\: yield\: expressed \:in \: \%.\)
- \(R\:= \:coupon\: rate.\)
- \(P\:=\: purchase\: price\: of\: the \:investment.\)
So, if we use the same parameters as last month’s example:
A four-year bond, purchased at £95, paying annual 3% coupons would have a current yield of 3.16%.
\(3.16\%=\:\frac{3}{95}\:*\:100\)
The main advantage of the current yield calculation measurement is:
- It is more straightforward than the formula for YTM we explained last month.
The disadvantages of this measurement are:
- It does not take into account any potential capital appreciation or loss
- It ignores interest on interest received.
YTM v Current Yield
Apart from the associated advantages and disadvantages, there are two important factors which should be taken into account if deciding whether to use YTM or the current yield to calculate returns on investment:
- If the bond is purchased at a discount, the yield to maturity will generate more than the current yield.
- However, if the bond is purchased at a premium, the current yield will realise more.
Other Yields
Other yield measurements do exist, but are not as commonly used as the YTM and current yield measurements. For example, the Japanese bond market uses the simple yield to maturity measurement. This yield takes account of the capital gained or lost on the investment, but does not take into account compound interest, ie interest on interest.
