Businesses and governments borrow money from investors by issuing bonds, which provide returns called yields.
A bond’s yield is measured in different ways. Two common yields that investors look at are current yield and yield to maturity. Current yield is a snapshot of the bond’s annual rate of return, while yield to maturity looks at the bond over its term from the date of purchase.
What’s the Difference Between Current Yield and Yield to Maturity?
|Current Yield||Yield to Maturity|
|Time Horizon||1 year||Purchase to maturity|
|Formula||Coupon/Price||Use quote tables, financial calculator, or Excel function|
|Investor Focus||Income||Overall performance|
Bonds are bought and sold in the market at par, a discount to par, or a premium to par. Par is the principal of the bond, or the face value, such as $100 or $1,000 per bond. Bond prices are quoted as a percent of par.
A price below 100% is considered a discount, and a price above 100% is considered a premium. Interest payments to the investor are based on the “coupon rate” and par value.
Current yield measures the income of a bond as a percentage of the purchase price. If the bond is purchased at a discount, the current yield is higher than the coupon rate, and lower than yield to maturity. If the bond is purchased at a premium, the current yield is lower than the coupon rate and higher than the yield to maturity.
Yield to maturity is the rate of return of the entire bond cash flow, including the return of principal at the end of the bond term. Yield to maturity is a way to compare bonds with different market prices, coupon rates, and maturities.
The current yield of a bond is easily calculated by dividing the coupon payment by the price. For example, a bond with a market price of $7,000 that pays $70 per year would have a current yield of 7%.
Calculating the yield to maturity is more complicated. You will need to factor in the coupon payment, maturity value, years to maturity, and price using a series of estimates.
The easiest way to find yield to maturity is in the bond quote tables published in financial journals and websites. Some financial calculators such as the HP12-C and computer programs such as Microsoft Excel can help you quickly calculate the yield to maturity.
Current yield may give investors who are focused primarily on income (e.g., retirees) enough information because it reflects yield from the bond that they can factor in as annual income. Most of the time, however, current yield is of limited use.
Yield to maturity is generally the measure most investors use to compare bonds. That’s because yield to maturity gives investors a better picture of overall returns, the impact of compound interest, and reinvestment risk.
Example of Current Yield vs. Yield to Maturity
Let’s look at two hypothetical $1,000 bonds with different coupon rates, maturities, and market prices.
|Coupon||Years to Maturity (as of 2022)||Market Price||Current Yield||Yield to Maturity|
|ABC 7% 2028||7%||7||$1,250.00||5.6%||2.99%|
|XYZ 3.15% 2028||3.15%||7||$980.00||3.20%||3.48%|
With these two examples, you can see the role a bond’s current market price plays in its yields. The ABC 7% bond is selling at a premium to the $1,000 face value, likely because the coupon rate of 7% is much higher than current interest rates. So the current yield is lower than the coupon payment.
By today’s standards, that’s very attractive, but it’s only part of the story. When the bond matures, the investor receives $1,000, the par value, which is considerably less than the $1,250 purchase price. That’s why the yield to maturity is only 2.99%.
In contrast, the XYZ 3.15% bond’s current market price is $980, a discount to the $1,000 face value. Its current yield of 3.2% and its yield to maturity of 3.48% are higher than its coupon rate because of the discount.
While the current yield of one bond may be more attractive, the yield to maturity of another could be substantially higher. Since yield to maturity is a more comprehensive metric, investors typically use it instead of current yield to compare bonds with different coupons, prices, and maturities.
The Bottom Line
For bond investors, yield is the interest and capital gains earnings. Current yield and yield to maturity are two common metrics bond investors use to compare bonds.
Yield to maturity is more widely used, and is a more comprehensive metric than current yield. Investors can find both types of yields in bond quotes provided by financial services websites and providers, and use them when comparing returns on bonds they’re considering for their own portfolios.
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