Which of the following is the amount earned annually from the interest payment compared with the price of the bond reflected as a percentage return? A) Coupon rate B) Par value C) Maturity D) Current yield
The correct answer and explanation is:
Correct Answer: D) Current yield
Explanation:
The current yield of a bond is the measure of the annual income (interest or coupon payment) earned from the bond relative to its current market price. It is expressed as a percentage and is commonly used by investors to evaluate the return they are receiving based on the bond’s market value rather than its original face value or par value.
The formula for current yield is:
Current Yield = (Annual Coupon Payment / Current Market Price) × 100
For example, suppose a bond has an annual coupon payment of $50 and it is currently selling for $900 on the market. The current yield would be:
Current Yield = (50 / 900) × 100 = 5.56%
This means an investor buying the bond at $900 earns a 5.56% return annually on their investment based on the bond’s current price.
Let us now differentiate the other options:
- A) Coupon rate refers to the fixed annual interest rate paid by the bond based on its par value. It does not account for changes in the market price of the bond. For instance, if the par value is $1,000 and the bond pays $60 annually, the coupon rate is 6 percent.
- B) Par value (or face value) is the amount the bond issuer agrees to repay at maturity. It is not a measure of return but rather the principal amount of the bond.
- C) Maturity indicates the date on which the bond will mature and the issuer will repay the par value to the bondholder. It does not reflect the return on investment.
Therefore, current yield is the most accurate representation of the return a bondholder earns annually based on the bond’s current price.