What does the effective yield on a bond equal?

What does the effective yield on a bond equal?

• A. Principle payment / current market price
• B. Coupon payment / current bid price
• C. Face value / market yield
• D. Interest income / remaining balance

Answer: (B)

The effective yield on a bond is calculated as the annual coupon payment divided by the current market price of the bond. This reflects the return an investor can expect if they purchase the bond at its current market price rather than its face value. The formula highlights how the yield can change with fluctuations in the market price of the bond. When the market price of a bond decreases, the yield effectively increases, which is important for investors assessing the attractiveness of their fixed-income investments. In the context of the other options, the first choice incorrectly implies that principal payment relative to the current market price determines the yield, which doesn’t accurately convey the bond's income-generating potential. The third choice refers to face value divided by market yield, a concept that doesn't provide a clear measure of yield in relation to the current market environment. The fourth choice suggests a relationship between interest income and remaining balance, which is more applicable to loans rather than bonds and does not accurately calculate yield in a bond context.

The effective yield on a bond is calculated as the annual coupon payment divided by the current market price of the bond. This reflects the return an investor can expect if they purchase the bond at its current market price rather than its face value. The formula highlights how the yield can change with fluctuations in the market price of the bond. When the market price of a bond decreases, the yield effectively increases, which is important for investors assessing the attractiveness of their fixed-income investments.

In the context of the other options, the first choice incorrectly implies that principal payment relative to the current market price determines the yield, which doesn’t accurately convey the bond's income-generating potential. The third choice refers to face value divided by market yield, a concept that doesn't provide a clear measure of yield in relation to the current market environment. The fourth choice suggests a relationship between interest income and remaining balance, which is more applicable to loans rather than bonds and does not accurately calculate yield in a bond context.