Yield when price changes

Quantitative Finance Level 1

An investor bought a bond with a constant coupon rate for $1000 with a current yield of 6%. If the price drops to $800, what happens to the curent yield of the bond?

Increases to 7.5% Decreases to 4.8% Increases to 8% Decreases to 4.5%

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Calvin Lin by Calvin Lin

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2 solutions

Chew-Seong Cheong
Mar 16, 2015

Current yield is given by:

Current Yield = Annual Cash Inflows Market Price \text{Current Yield}=\dfrac {\text {Annual Cash Inflows}}{\text {Market Price}}

Therefore, the Annual Cash Inflows = 1000 × 0.06 = 60 \text {Annual Cash Inflows} =1000 \times 0.06=60

The New Current Yield = 60 800 = 7.5 % \text {New Current Yield }=\dfrac {60}{800 }=\boxed {7.5\%}

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Phil Zimmz
Apr 11, 2018

Intuitively, before even crunching the math, you know that as price drops, the yield must increase, because the coupon stays the same. As a result, you can quickly eliminate the two answer choices that related to "decreasing."

Next, simply plug the values in for the Market Price and Current Yield. Then re-arrange the equation solving for the original coupon rate ($60). To solve for the current yield, take this coupon rate and divide by the current price ($800), to arrive at 7.5% ($60/$800).

3 Helpful 0 Interesting 0 Brilliant 0 Confused

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