10th letter to friends of Brunei (Bond's Valuation [part 2])

Most bonds are purchased from the secondary market. The price of such bond can be more (premium) or less (discount) than the bond par value. By dividing the coupon interest with the bond price, we would know how much interest income you will receive each year relative to the price you are paying for the bond.

Current Yield = Annual Coupon / Bond Price

Example 1: A $1,000 par value bond pays a $100 annual coupon has a price of $1,050. What is its current current yield?

a. 10.00%
b. 5.00%
c. 3.50%
d. 9.52%


Example 2: The same $1,000 par value bond that pays $100 annual coupon now has a price of $960. What is the current yield?

a. 10.00%
b. 10.42%
c. 4.00%
d. 3.50%

In these 2 examples, you will notice an interesting truth about bond yield and price. When price goes up, the yield will come down; and the reverse is true.


* The working for example 1 is $100/$1050 = 0.0952 (or 9.52%), hence the answer is d.

** The working for example 2 is $100 / $960 = 0.1042 (or 10.42%), hence the answer is b.