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What is the relationship between the current yield and risk?

A:

The general relationship between current yield and risk is that they increase in correlation to one another. A higher current yield is usually accompanied by a higher level of risk.

Investing in Bonds

Risk is inherent in any type of investment. The balance between risk and returns depends on the type of investment. Bonds are considered one of the least risky investments, particularly in comparison stocks. Bonds typically pay investors a fixed rate of interest income. The bond market is historically less volatile and vulnerable to price swings than is the equity market.

The risk level of a bond is reflected in its return, also known as its current yield, which is a function of its coupon rate and current price. The coupon rate of a bond is the yearly interest rate that the issuer promises to pay to the investor, stated as a percentage of the bond's face or par value. The current price of the bond may be at a premium, or discount, to the bond's par value.

The current yield of a bond needs to be higher to compensate for higher risk. If the market determines that a bond's current yield is too low, the price will drop to bring the yield to the same level as the market's expectation – or more in line with prevailing interest rates.

U.S. Treasury bonds (T-bonds) are fully backed by the U.S. government. They are considered to have virtually no risk. The market for these securities is also highly liquid, which means that there are always investors seeking to buy them. The risk level of various other bond issues, such as corporate or municipal bonds, is often compared to the risk-free level of interest that can be earned on T-bonds.

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