Final answer:
The current yield on a bond is most similar to the dividend yield on a stock, both representing the income return relative to the current market price, without accounting for capital gains or losses. It is simply calculated by dividing the annual interest payments by the market price of the bond. Therefore, the correct option is 3.
Step-by-step explanation:
The current yield on a bond is a measure of the income return on the bond investment, relative to the current price of the bond. It does not take into account capital gains or losses that may be realized if the bond is sold before maturity. The most similar concept to the current yield on a bond from the options provided would be the dividend yield on a stock because both represent the income earning capacity of the investment in relation to its current market price. The current yield is calculated by dividing the annual interest payments by the market price of the bond. For example, if a bond with a face value of $1,000 and an annual coupon payment (interest payment) of $80 is bought for $964, the current yield can be calculated as ($80 / $964) × 100%, which results in approximately an 8.3% current yield. This provides a straightforward comparison to the dividend yield on a stock, which is similarly calculated by dividing annual dividends by the stock's market price. Unlike the internal rate of return (IRR), which is applicable if the bond is held to maturity and accounts for all cash flows and time value of money, the current yield only considers the income aspect and not the total return over the life of the bond.