The current yield on fixed-income securities plays a similarly important role on the capital market as the DAX does on stocks. It is determined for different market segments, which is why the term “current returns” is more appropriate.
- The current yield on federal securities is considered to be the value for the lowest-risk bonds.
- The Bundesbank determines the current returns on every trading day and is published on the Bundesbank’s website.
- The current yield on government bonds is used as a reference rate for comparing low-risk and high-risk investments.
The definition of current yield
Short for CY by abbreviationfinder, the current yield reflects the average yield on low-risk bonds . It only relates to German government and municipal bonds and bonds from issuers with first-class credit ratings . Only bonds with a term of at least four years up to 30 years and a remaining term of at least three years are taken into account. Papers denominated in foreign currency are not taken into account. The weighting of the individual bonds is based on the respective market value. In addition, the weighting is carried out according to a certain key in order to avoid distortions due to large emissions compared to smaller ones.
Due to the narrow selection of papers that are used to determine the current yield, the current yield does not, of course, reflect the entire market for fixed-income securities , but only the risk-free portion.
How does the Bundesbank determine the current yield?
The current return is what is known as a secondary market return. It is based only on papers that have been in circulation for a long time. In contrast, the primary market or issue yield reflects the yield that paper shows on the first day after its issue. The procedure is the same, the interest income is set in relation to the market value.
The Bundesbank determines the current yields every trading day. This factor is thus updated on a daily basis. The Bundesbank statistics are divided into three groups:
- Public Sector Bonds
- Industrial bonds
- Bank bonds
The current yield on public bonds
The highest current yield was recorded in August 1981 at 11.2 percent. The negative current yield on listed federal securities is remarkable . This arises when the market value is so far above 100 percent of the nominal value that it exceeds the nominal interest rate. For example, if the price of a security is 102 percent, but the interest rate is only 1.5 percent, there is a negative return of 0.5 percent.
Current yield for reference
The current yield is used as the reference interest rate. The current yield on government bonds is used as a benchmark for the credit spread and the Sharpe ratio.
The credit spread reflects the difference between a risk-free and a risky investment and is also based on the term of the bond. The risk premium that the lender receives for the increased risk is determined from the credit spread.
The Sharpe quotient, better known as the “Sharpe Ratio”, determines the excess return of a risky investment compared to a safe investment in relation to the risk. If a risky fund has generated a return of 10 percent, whereas a safe investment only generates 2 percent, the fund’s excess return is 8 percent. This advantage must be set in relation to the risk of the investment (volatility).
Significance of the current yield for the insurance industry
Until June 2016, the current yield was of particular importance. According to Paragraph 3 of the Ordinance on the Basis of Calculation for the Insurance Provisions (DeckRV), the maximum actuarial interest rate for life insurers was only allowed to make up 85 percent of the average monthly current yield on government bonds. Since July 2016, the DeckRV has provided an interest rate of 1.25 percent.