Running yield

From CEOpedia | Management online

Running yield tells investors what they will earn if they buy the bond and hold it for one year[1]. Running refers to a continuous investment, such as a bond held to maturity. Also known as current yield, interest yield or yieldt maturity (YTM) when used in reference to bonds[2]

Definition

Running yield is the method used quite often to express the profits of debt instruments in the short periods[3].

The current price of the bond is taken into account instead of its face value. Is the return of what an investor would expect if you purchased a bond and held it for a year, but the current profitability is not the actual profit which the investor receives, if the bond is to maturity[4].

Model

It is calculated by dividing the coupon payments (for bonds) or the income from dividends (for stocks) by the clean price of the debt instrument, expressed as a percentage[5]

Assumptions

The purchased debt instrument is maintained for a certain period so that it can then be sold at the same price.

The coupon payments, defined as periodic payments, are included in the return on bonds, due to the fact that the rate of return refers to the price that has been paid for it. To calculate the running yield, use a clean price and not a dirty one[6].

Yield maturity (YTM)

Accounts for[7]:

We calculate it in order to compare the degree of attractiveness of investing in a particular bond with other investment opportunities. Often, it equates to an internal rate of return (IRR) of capital investment in bonds[8].

It is interpreted as a rate, which is obtained by investing in a bond investor had bought at a price of P (where P is the purchase price) and survived until the maturity obtained from reinvesting the interest at the rate of return[9].

YTM of debt fund dose not remain constant as[10]:

  • Portfolio changes actively
  • Market scenario changes

Examples of Running yield

  • The running yield of a bond is the current income it generates per year, expressed as a percentage of its face value. For example, a bond with a face value of $10,000 and a coupon rate of 5% per year will generate $500 of annual income. The running yield for this bond is 5%, or $500/$10,000.
  • The running yield of a bond will change over time as interest rates move, and the bond’s price changes. For example, if the bond mentioned above is purchased at a price of $9,500 (or a yield of 5.26%) and interest rates fall, the bond’s price may increase to $10,200 (yielding 4.90%). In this case, the running yield of the bond has fallen from 5.26% to 4.90%.

Advantages of Running yield

Running yield offers investors a variety of advantages. It gives investors a clear and straightforward way to compare different bonds and assess the potential return on their investment. Specifically, the running yield provides investors with the following benefits:

  • It provides a concrete measure of the expected return on a bond over a one-year period. This makes it easier for investors to make informed decisions about their investments and to compare different bonds.
  • It takes into account the coupon rate, the market value of the bond, and the current interest rate environment of the market. This helps investors accurately calculate the potential return they can expect from a bond over a one-year period.
  • It gives investors a reliable measure of risk by considering the current market conditions and the particular bond’s coupon rate. This helps investors make well-informed decisions about their investments and minimize the risks associated with investing in bonds.

Limitations of Running yield

Running yield is a useful tool for investors to assess the performance of a bond over a one-year period. However, it has some limitations that investors should be aware of before relying solely on this measure. The main limitations are as follows:

  • Running yield does not consider the impact of market fluctuations, so it does not reflect how the bond will perform in the long run.
  • Running yield does not take into account the bond's coupon rate, which will affect the bond's performance over time.
  • Running yield does not consider the bond's creditworthiness or the issuer's financial health, which could affect its ability to pay back the principal.
  • Running yield does not factor in any changes in interest rates, which can significantly alter the bond's performance.
  • Running yield does not consider the liquidity of the bond, which can affect its price.

Other approaches related to Running yield

One way to understand the yield on a bond is to look at the running yield. This is a measure of how much income, such as interest payments, investors will receive if they purchase and hold the bond for one year. However, there are other approaches that investors can use to assess the yield of a bond:

  • Yield to Maturity (YTM): This is the rate of return investors will get if they hold the bond until it reaches maturity. YTM takes into account the current market price of the bond, the coupon rate and the time until maturity.
  • Current Yield: This is calculated by dividing the annual coupon payments of a bond by the price of the bond. It is a measure of the current income the bond will generate.
  • Yield to Call (YTC): This is the rate of return investors will receive if the bond is called, or redeemed, before it reaches maturity. YTC takes into account the current market price of the bond, the coupon rate and the time until the bond is called.

In summary, there are a few different approaches investors can use to assess the yield of a bond, including yield to maturity, current yield and yield to call.

Footnotes

  1. ↑ Bhat S.,2008, p.216
  2. ↑ CTI Reviews, 2016, p.
  3. ↑ Colin A., 2016, ch. 9.3
  4. ↑ Ranganatham M., Madhumathi R., 2006, p.119-120
  5. ↑ Jones P., Jensen R., 2016, p. 442
  6. ↑ CTI Reviews, 2016, ch.
  7. ↑ Wong Robert A., High R.,1993, p.77-78
  8. ↑ Mayo B. H., 2016, p.290
  9. ↑ Cebula R., Billy Y., 2008, p.
  10. ↑ Jones P., Jensen R., 2016, p. 443


Running yield — recommended articles
Economic value of equity — WACC — Net yield — Asset-swap spread — Market Risk Premium — Free cash flow yield — Profit factor — Annualized rate — Yield on cost

References

Author: Agnieszka Katarzyna Sikora

.

Retrieved from "https://ceopedia.org/index.php?title=Running_yield&oldid=97652"