Current yield and to maturity relationship

Current yield - Wikipedia

There are several definitions that are important to understand when talking about yield as it relates to bonds: coupon yield, current yield, yield-to-maturity. Yield to maturity or YTM and Current yield are terms that are on the relationship between the current price of bonds and the annual interest. A bond's yield to maturity (YTM) is the estimated rate of return based on the current price of the bond, the difference between price and face.

The risk that the financial health of the issuer will deteriorate, known as credit risk, increases the longer the bond's maturity. As a result, bonds with longer maturities also tend to pay more in order to compensate investors for the additional risk. Inflation Inflationary conditions generally lead to a higher interest rate environment. Therefore, inflation has the same effect as interest rates. When the inflation rate rises, the price of a bond tends to drop, because the bond may not be paying enough interest to stay ahead of inflation.

Bonds - Confused between the rates: Spot, Forward, Coupon, Current Yield, IRR, YTM, BEY

The longer a bond's maturity, the more chance there is that inflation will rise rapidly at some point and lower the bond's price. That's one reason bonds with a long maturity offer somewhat higher interest rates: They need to do so to attract buyers who otherwise would fear a rising inflation rate. That's one of the biggest risks incurred when agreeing to tie up your money for, say, 30 years. Minimizing bond price confusion Bond pricing involves many factors, but determining the price of a bond can be even harder because of how bonds are traded.

Because stocks are traded throughout the day, it's easier for investors to know at a glance what other investors are currently willing to pay for a share.

  • Mutual Funds and Mutual Fund Investing - Fidelity Investments
  • Market Update
  • Yields That Matter More

But with bonds, the situation is often not so straightforward. Prices on statements may not be what you paid The price you see on a statement for many fixed-income securities, especially those that are not actively traded, is a price that is derived by industry pricing providers, rather than the last-trade price as with stocks.

The derived price takes into account factors such as coupon rate, maturity, and credit rating. The price is also based on large trading blocks. But the price may not take into account every factor that can impact the actual price you would be offered if you actually attempted to sell the bond. Derived pricing is commonly used throughout the industry.

Of the hundreds of thousands of bonds that are registered in the United States, less thanare generally available on any given day. These bonds will be quoted with an offered price, the price the dealer is asking the investor to pay.

Treasury and corporate bonds are more frequently also listed with bid prices, the price investors would receive if they're selling the bond.

Less liquid bonds, such as municipal bonds, are rarely quoted with a dealer's bid price. If the bid price is not listed, you must receive a quote from a bond trader. Call a Fidelity representative at Yield Yield is the anticipated return on an investment, expressed as an annual percentage. There are several ways to calculate yield, but whichever way you calculate it, the relationship between price and yield remains constant: The higher the price you pay for a bond, the lower the yield, and vice versa.

Current yield is the simplest way to calculate yield: While current yield is easy to calculate, it is not as accurate a measure as yield to maturity. The yield to maturity in this example is around 9. Yield to maturity Yield to maturity is often the yield that investors inquire about when considering a bond. Yield to maturity requires a complex calculation. It considers the following factors.

Coupon rate—The higher a bond's coupon rate, or interest payment, the higher its yield. That's because each year the bond will pay a higher percentage of its face value as interest.

Price—The higher a bond's price, the lower its yield. That's because an investor buying the bond has to pay more for the same return. Years remaining until maturity—Yield to maturity factors in the compound interest you can earn on a bond if you reinvest your interest payments. Difference between face value and price—If you keep a bond to maturity, you receive the bond's face value.

The actual price you paid for the bond may be more or less than the face value of the bond. Yield to maturity factors in this difference.

Current Yield

It is 5 years from maturity. The bond's current yield is 6. Coupon yield is the annual interest rate established when the bond is issued. It's the same as the coupon rate and is the amount of income you collect on a bond, expressed as a percentage of your original investment. This amount is figured as a percentage of the bond's par value and will not change during the lifespan of the bond Current yield is the bond's coupon yield divided by its market price.

Bond Yield and Return |

Here's the math on a bond with a coupon yield of 4. The current yield has changed: If you buy a new bond at par and hold it to maturity, your current yield when the bond matures will be the same as the coupon yield.

Yields That Matter More Coupon and current yield only take you so far down the path of estimating the return your bond will deliver. For one, they don't measure the value of reinvested interest. They also aren't much help if your bond is called early—or if you want to evaluate the lowest yield you can receive from your bond.

Current yield

In these cases, you need to do some more advanced yield calculations. Fortunately, there is a spate of financial calculators available—some that even estimate yield on a before- and after-tax basis. The following yields are worth knowing, and should be at your broker's fingertips: Yield to maturity YTM is the overall interest rate earned by an investor who buys a bond at the market price and holds it until maturity.

Mathematically, it is the discount rate at which the sum of all future cash flows from coupons and principal repayment equals the price of the bond. It assumes that coupon and principal payments are made on time. It does not require dividends to be reinvested, but computations of YTM generally make that assumption. Further, it does not consider taxes paid by the investor or brokerage costs associated with the purchase. Yield to call YTC is figured the same way as YTM, except instead of plugging in the number of months until a bond matures, you use a call date and the bond's call price.

This calculation takes into account the impact on a bond's yield if it is called prior to maturity and should be performed using the first date on which the issuer could call the bond. If you want to know the most conservative potential return a bond can give you—and you should know it for every callable security—then perform this comparison.

Yield reflecting broker compensation is the yield adjusted by the amount of the mark-up or commission when you purchase or mark-down or commission when you sell and other fees or charges that you are charged by your broker for its services. You hold your bond to maturity or call date. You reinvest every coupon. Interest rates regularly fluctuate, making each reinvestment at the same rate virtually impossible. Such a figure is only accurately computed when you sell a bond or when it matures.