Yield Current: A Straightforward Measure for Bond Buyers (Equation, Computation, Disadvantages)
In the world of finance, two key metrics are often used to evaluate the potential return on a bond investment: Current Yield and Yield to Maturity (YTM). Both have their own strengths and weaknesses, and understanding them can help investors make informed decisions.
Current Yield, as the name suggests, estimates the income generated from a bond investment over the next year. It is calculated by dividing the annual coupon payment by the bond's current market price and multiplying the result by 100%. A higher current yield generally indicates a higher potential return on investment, but it's important to consider factors such as the issuer's creditworthiness and market conditions.
On the other hand, Yield to Maturity (YTM) provides a more comprehensive picture of a bond's total return potential. It incorporates both the annual coupon payments and the bond's price at maturity. In simpler terms, it calculates the annualized rate of return an investor would earn if they held the bond until its maturity date and reinvested all coupon payments at the same rate.
Current Yield focuses on the immediate income potential of a bond, while Yield to Maturity considers the bond's entire life. For investors who plan to hold the bond until maturity, Yield to Maturity offers a more accurate reflection of the bond's total return potential.
The annual coupon payment is determined by multiplying the bond's face value by its coupon rate. The current market price is the price at which the bond trades. Current Yield can provide insights into a bond's valuation relative to its par value. However, it doesn't account for potential capital gains or losses that may occur as the bond approaches maturity. In contrast, Yield to Maturity accounts for these potential gains or losses.
In 2023, some companies like Uber, Netflix, Coca-Cola, PepsiCo, Philip Morris, and Honeywell have been noted for borrowing short-term due to expectations of future rate cuts, indicating flexibility but typically not the highest yields. For high current yields, riskier bonds like those in the Aberdeen Frontier Markets Bond Fund, which includes issuers from frontier markets such as Egypt (24% coupon), Uzbekistan (15.5%), and Uganda (14.25%), offer substantially higher yields but come with increased risk. Major banks like KfW and Canadian banks (Bank of Montreal, Bank of Nova Scotia) offer highly rated bonds with lower yields around ms +19 basis points but are considered safer.
It's crucial to remember that the current yield assumes that coupon payments can be reinvested at the same rate as the current yield, which may not always be true. Also, for a more comprehensive analysis, investors should consider both the current yield and the yield to maturity of a bond.
In conclusion, while Current Yield and Yield to Maturity offer different perspectives on a bond's potential return, understanding both can help investors make informed decisions based on their investment goals and risk tolerance.
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