Definition
Yield is an accounting term referring to the income generated from an investment, often expressed as a percentage of either its par value or market value. There are several types of yield:
- Nominal Yield: The interest paid by a fixed-interest security, shown as a percentage of its par value. For example, a £100 stock paying 8% provides a nominal yield of £8 annually per £100 of stock.
- Current Yield: Also known as interest yield, running yield, earnings yield, or flat yield, this yield reflects the return on the current market price. For instance, if the £100 stock with an 8% interest rate is priced at £90, the current yield is calculated as \( \frac{100}{90} \times 8 = 8.9% \).
- Yield to Redemption: Also called gross redemption yield or maturity yield, this yield considers both the current yield and the capital gain (or loss) on redemption.
The general formula for calculating redemption yield is: \[ \text{Redemption Yield} \approx \text{Current Yield} + \frac{\text{Capital Gain}}{\text{Years to Redemption}} \] If the given stock mentioned above has nine years to redemption, its redemption yield could be around \( 8.9% + \frac{10}{9} = 10% \).
- Dividend Yield: For equities, the dividend yield is calculated but does not consider potential capital gains or losses, reflecting the higher risk level associated with equity investments.
Examples
- Nominal Yield Example: A bond with a face value of $1,000 pays $50 annually. The nominal yield is \( \frac{50}{1000} \times 100% = 5% \).
- Current Yield Example: The same bond’s market value is now $900 while continuing to pay $50 annually. The current yield is \( \frac{50}{900} \times 100% \approx 5.56% \).
- Yield to Redemption Example: Assume the bond mentioned above is to be redeemed in 10 years. If the bond is redeemed at $1,100, the capital gain is $100. Consequently, the yield to redemption is approximately \[ 5.56% + \frac{100}{10} = 5.56% + 1% = 6.56% \].
Frequently Asked Questions (FAQs)
What is nominal yield?
Nominal yield, also known as the coupon yield, is the interest rate stated on a bond or note, expressed as a percentage of the face value.
How is current yield different from nominal yield?
Current yield reflects the income from a bond based on its current market price, whereas nominal yield is calculated based on the bond’s face value.
What is yield to maturity?
Yield to maturity (YTM) is the total return anticipated on a bond if the bond is held until it matures, accounting for all coupon payments and the face value upon redemption.
How do interest rate changes affect bond yields?
When interest rates rise, bond prices typically decline, increasing the current yield and vice versa.
What role does yield play in stock investments?
In equities, yield commonly refers to dividend yield, estimating the cash dividend income as a percentage of the current stock price.
Can yields be calculated for non-fixed income securities?
Yes, yields can be calculated for dividends of stocks but are fluctuating as dividends are not guaranteed and can change.
Why are yields usually quoted gross?
Yields are often quoted gross before the deduction of tax to provide a standard measure for comparison across different securities and investors.
What is a high-yield bond?
A high-yield bond, also known as a junk bond, offers higher yields due to higher risk of default compared to investment-grade bonds.
How can investors use yield information?
Investors may use yield information to assess the attractiveness and risk profile of various investments to make better-informed choices.
Are yields guaranteed?
No, yields are not guaranteed; they can fluctuate with market conditions and the performance of the underlying investment.
Related Terms
- Par Value: The face or nominal value of a security stated by the issuer.
- Coupon Rate: The annual interest rate paid on a bond’s face value.
- Bond: A fixed income instrument representing a loan made by an investor to a borrower.
- Dividend: A portion of a company’s earnings distributed to shareholders.
- Market Price: Current price at which a security is traded in the market.
- Interest Rate: The percentage charged or paid for the use of money.
Online References
Suggested Books for Further Studies
- “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi
- “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman and Angel Serrat
- “The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau
- “Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
Accounting Basics: “Yield” Fundamentals Quiz
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