FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client is considering purchasing a municipal bond with a 5.0% coupon rate, currently trading at $980. What is the current yield of this bond?
- A4.90%
- B5.00%
- C5.25%
- D5.10%
Show answer & explanationAnswer & explanation
Correct answer: D. 5.10%
The current yield of a bond is calculated by dividing its annual interest payment by its current market price. The annual interest is based on the coupon rate and the par value.
Why the other options are wrong
- A. This represents the current market price as a percentage of par value, not the current yield.
- B. This is the coupon rate, not the current yield. The current yield will be higher than the coupon rate when the bond is trading at a discount.
- C. This is an incorrect calculation and overestimates the current yield.
Current Yield (Bonds)
Current yield measures the annual income an investor receives from a bond relative to its current market price. It is calculated by dividing the bond's annual interest payment by its current market price.
- Formula: Annual Interest Payment / Current Market Price.
- Does not consider capital gains or losses if held to maturity.
- When a bond trades at a discount, its current yield is higher than its coupon rate.
- When a bond trades at a premium, its current yield is lower than its coupon rate.
Memory trick: Current yield is 'annual interest' divided by 'current price'—think 'AICP'.