Understanding Bond Yields: Current Yield vs. Yield to Maturity

Bonds are often seen as low-risk, reliable investments, making them a popular choice for many investors. Issued by corporations and government entities to raise capital, bonds essentially represent a loan from the investor to the issuer. In return, the issuer is obligated to repay the loan over time with interest. When evaluating bonds, two key metrics to consider are the current yield and the yield to maturity. Each provides valuable insights but serves different purposes.

What Is Current Yield?

The current yield of a bond is a measure of the return you’re getting right now based on the bond’s current price. To calculate the current yield, you divide the annual interest payment by the bond’s current price. This metric provides a snapshot of the bond’s cash flow and can fluctuate depending on the bond’s price at any given time.

Comparing current yields on different bonds can help guide your investment strategy. However, it’s important to remember that the current yield focuses on the present moment and does not reflect the bond’s total returns at maturity.

What Is Yield to Maturity?

Yield to maturity (YTM) offers a more comprehensive evaluation of a bond, taking a longer-term view. YTM looks at the annual rate of return if the investor holds the bond until it matures. It factors in all coupon payments (interest payments) and the return of the principal (the original purchase amount) when the bond matures.

Calculating YTM is more complex than calculating the current yield. The formula is as follows:

Coupon payment + ((face value — present value) / number of years to maturity)
(Face value + present value) / 2

The face value, or par value, is the bond’s value when first issued and the amount you’ll get back at maturity. The coupon rate, which is the interest the bond pays, typically remains unchanged once the bond is issued. If you buy a bond at face value, the YTM is the same as the coupon rate. However, the YTM will be higher if you buy the bond at a discount and lower if you buy it at a premium.

Current Yield vs. Yield to Maturity

While both current yield and yield to maturity are useful metrics, they serve different purposes:

• Current Yield: Measures the income provided by the bond at a given moment. It is calculated by dividing the annual interest payment by the current bond price. This metric helps evaluate the bond’s present cash flow.
• Yield to Maturity: Predicts the bond’s total potential returns over its life, assuming the investor holds it until maturity. It uses a more complex calculation involving the coupon payment, present value, face value, and the time to maturity. This metric helps predict long-term returns.

Example of Current Yield vs. Yield to Maturity

Let’s consider a bond currently priced at $800 with a face value of $1,000 and a coupon rate of 6%. The annual interest payment is $60, and the maturity period is 10 years. To calculate the yield to maturity:

60 + ((1,000 — 800) / 10) = 80
(1,000 + 800) / 2 = 900
80 / 900 = 0.0888

The yield to maturity in this case is 8.9%.

Now, let’s calculate the current yield. We divide the annual interest payment ($60) by the current bond price ($800), resulting in a current yield of 7.5%. In this example, the yield to maturity is higher than the current yield.

The Bottom Line

There are multiple ways to calculate bond yields, each offering different insights. The yield to maturity provides a more accurate long-term prediction, while the current yield offers a snapshot of the bond’s present cash flow. Both metrics are valuable for refining your investment strategy.

At O1ne Mortgage, we understand that your investment portfolio is just one piece of your overall financial health. If you have any questions or need assistance with your mortgage needs, don’t hesitate to call us at 213-732-3074. Our team of experts is here to help you make informed decisions and achieve your financial goals.

Remember, your financial well-being is our top priority. Contact O1ne Mortgage today for all your mortgage service needs!