‘Current Yield’ and ‘Coupon Rate’ are two different terms, but these terms are related to bonds and shares. Many people turn towards other methods like mutual funds, stock market, share market, etc., to invest their money for better returns. So these two terms are essential to understand how the market works.
Current Yield vs Coupon Rate
The main difference between current yield and coupon rate is that current yield is a ratio of annual income from the bond to the current price of the bond, and it tells about the expected income generated from the bond. In contrast, the coupon rate is a fixed interest paid by the issuer annually on the face value of a bond.
The Current Yield is a mathematical instrument that can tell about expected income from any investment. Generally, it is used for bonds. It can be calculated by dividing the annual income from the bond by the current price of the bond. It is an excellent method to check expectations from a bond.
A Coupon Rate is a fixed interest that a bondholder gets annually until it completely matures, whatever is the current status of bond value. Generally, the annual amount due to the coupon rate is paid twice a year. It does not depend on bonds face value or par value.
Comparison Table Between Current Yield and Coupon Rate
| Parameters of Comparison | Current Yield | Coupon Rate |
| Definition | It is expected annual income from a bond. | It is a fixed amount of interest an issuer gets annually. |
| Nature | It keeps changing for a particular bond with time intervals. | It is a fixed interest and does not change for a particular bond. |
| Formula | Annual cash payment ÷ Market price | (Total annual coupon payment ÷ Face value of bond) × 100% |
| Risk Effect | It can be affected by risk. | It does not get affected by any risk. |
| Relevance | It is just a tool to check expectations. | It is an actual percentage that stockholder gets. |
What is Current Yield?
The Current Yield is a method of bond yield measurement, which measures annual income from stock. It tells the investor the expected return from the bond if he invests in the bond for one year. The price of bonds keeps regularly changing, so the current yield is not an actual amount. Instead, it is an expected return only.
The Current Yield is dependent on the current market price, so it keeps changing. For example, an XYZ issued a bond with a face value of $2000, and its annual coupon payment is $150. Now the current market price of bonds is $1800, so the current yield can be calculated, which results in the current yield equals to 8.33%.
The Current Yield can be equal to the coupon rate in some rare cases when a bond market price gets equal to its face value. It is higher when the bond market price gets lower than its face value, and it is lower when the bond market price is higher than its face value.
There are many other methods like current yield to calculate bond yield like Yield to Maturity. The investor should consider all scenarios and check return as current yield does not consider time effect on bond return. These points can help to choose a perfect bond for a higher return.
What is Coupon Rate?
Coupon Rate is the actual amount that a holder gets for any bond. It is paid annually till it gets mature. It is a rate of interest. This rate of interest is generally fixed by the government. It remains fixed whether the market value of the bond fall or rises, so it is an assured amount for a stockholder, whatever is the condition.
It is a fixed return on the bond. For example, if a company issued a bond with a face value of $100 and the coupon rate is 10%, it pays $10 annually to the bondholder. In general, it is paid two times semi-annually.
In most cases, investors prefer bonds with a high coupon rate. Sometimes coupon rate can also be zero, and it is preferred by insurance companies as the insurance companies’ interest rate risk is minimized with the help of zero-coupon bonds.
It is known as Coupon Rate. It s because, initially, investors used to get a sheet of paper coupons while purchasing a bond, which could be redeemed at regular intervals of time in exchange for real money. Now in the age of digitalization, payments are made electronically.
Main Differences Between Current Yield and Coupon Rate
- The main difference between the current yield and coupon rate is that the current yield is just an expected return from a bond, and the coupon rate is the actual amount paid regularly for a bond till it gets mature.
- The Current Yield keeps changing as the market value of the bond changes, but the Coupon Rate of a particular bond remains the same.
- The Current Yield can be calculated by taking the ratio of annual cash payment and the market price of the bond. On the other hand, the Coupon Rate is calculated by taking the percentage ratio of coupon payment to the face value of the bond.
- The Current Yield can be affected by the risk of the market, whereas the Coupon Rate does not affect by any condition of the market.
- The Current Yield is a value that depends on the market price of a bond, while the Coupon Rate is fixed by the government before issuing a bond.
Conclusion
Investing money in the right place can give you higher returns that can help your future, but a wrong decision can lead to higher loss or put you under debt. So, study the market and all the related terms in detail to take a decision wisely. Similarly, Current Yield and Coupon Rate are two terms that can help an investor to take the decision.
Current Yield and Coupon Rate both help in determining the best stock to invest in. The first one determines the expected return, and the latter determines the fixed annual income from the bond. Both of the terms with some other tools should be used wisely before investing.
References
- https://www.jstor.org/stable/41862457
- https://search.proquest.com/openview/ff642164edae9a9f49d0f1d0af16452f/1?pq-origsite=gscholar&cbl=1816399