Yield (finance)
Encyclopedia
In finance
, the term yield describes the amount in cash that returns to the owners of a security
. Normally it does not include the price variations, at the difference of the total return. Yield applies to various stated rates of return on stocks (common and preferred, and convertible
), fixed income instruments (bonds, notes, bills, strips, zero coupon), and some other investment type insurance products (e.g. annuities).
The term is used in different situations to mean different things. It can be calculated as a ratio or as an internal rate of return
(IRR). It may be used to state the owner's total return, or just a portion of income
, or exceed the income.
Because of these differences, the yields from different uses should never be compared as if they were equal. This page is mainly a series of links to other pages with increased details.
or coupon yield is the yearly total of coupons
(or interest) paid divided by the Principal (Face) Value of the bond.
The current yield
is those same payments divided by the bond's spot market price.
The yield to maturity
is the IRR on the bond's cash flows: the purchase price, the coupons received and the principal at maturity.
The yield to call is the IRR on the bond's cash flows, assuming it is called at the first opportunity, instead of being held till maturity.
The yield of a bond is inversely related to its price today: if the price of a bond falls, its yield goes up. Conversely, if interest rates decline (the market yield declines), then the price of the bond should rise (all else being equal).
There is also TIPS (Treasury Inflation Protected Securities), also known as Inflation Linked fixed income. TIPS are sold by the US Treasury and have a "real yield". The bond or note's face value is adjusted upwards with the CPI-U, and a real yield is applied to the adjusted principal to let the investor always outperform the inflation rate and protect purchasing power. However, many economists believe that the CPI under-represents actual inflation. In the event of deflation over the life of this type of fixed income, TIPS still mature at the price at which they were sold (initial face). Losing money on TIPS if bought at the initial auction and held to maturity is not possible even if deflation was long lasting.
The dividend yield is the total yearly payments divided by the principal value of the preferred share.
The current yield
is those same payments divided by the preferred share's market price.
If the preferred share has a maturity (not always) there can also be a yield to maturity
and yield to call calculated, the same way as for bonds.
s to convert back into corporations. Investors seeking the high yields typically associated with the energy royalty trusts are increasingly investing in private mutual energy fund trusts.
is the total dollars (Yen, etc.) paid in a year divided by the spot price of the shares. Most web sites and reports are updated with the expected future year's payments, not the past year's.
The price/earnings ratio quoted for common shares is the reciprocal of what is called the earnings yield
. EarningsPerShare / SharePrice.
. $YearlyDistribution / $CostOfContract.
, Royalty trusts, and Income trusts often include cash that exceeds the income earned: that is return of capital
. $YearlyDistribution / $SharePrice.
Yield levels vary mainly with expectations of inflation
. Fears of high inflation in the future mean that investors ask for high yield (a low price vs the coupon) today.
The maturity of the instrument is one of the elements that determines risk
. The relationship between yields and the maturity of instruments of similar credit worthiness, is described by the yield curve
. Long dated instruments typically have a higher yield than short dated instruments.
The yield of a debt instrument is generally linked to the credit worthiness and default
probability of the issuer. The more the default risk, the higher the yield would be in most of the cases since issuers need to offer investors some compensation for the risk.
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
, the term yield describes the amount in cash that returns to the owners of a security
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
. Normally it does not include the price variations, at the difference of the total return. Yield applies to various stated rates of return on stocks (common and preferred, and convertible
Convertible bond
In finance, a convertible note is a type of bond that the holder can convert into shares of common stock in the issuing company or cash of equal value, at an agreed-upon price. It is a hybrid security with debt- and equity-like features...
), fixed income instruments (bonds, notes, bills, strips, zero coupon), and some other investment type insurance products (e.g. annuities).
The term is used in different situations to mean different things. It can be calculated as a ratio or as an internal rate of return
Internal rate of return
The internal rate of return is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return or the rate of return . In the context of savings and loans the IRR is also called the effective interest rate...
(IRR). It may be used to state the owner's total return, or just a portion of income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
, or exceed the income.
Because of these differences, the yields from different uses should never be compared as if they were equal. This page is mainly a series of links to other pages with increased details.
Bonds, notes, bills
The nominal yieldNominal yield
Nominal yield or coupon yield is the coupon rate of a fixed income security, which is a fixed percentage of the par value. Unlike current yield, it does not vary with the market price of the security....
or coupon yield is the yearly total of coupons
Coupon (bond)
A coupon payment on a bond is a periodic interest payment that the bondholder receives during the time between when the bond is issued and when it matures. Coupons are normally described in terms of the coupon rate, which is calculated by adding the total amount of coupons paid per year and...
(or interest) paid divided by the Principal (Face) Value of the bond.
The current yield
Current yield
The current yield, interest yield, income yield, flat yield or running yield is a financial term used in reference to bonds and other fixed-interest securities such as gilts...
is those same payments divided by the bond's spot market price.
The yield to maturity
Yield to maturity
The Yield to maturity or redemption yield of a bond or other fixed-interest security, such as gilts, is the internal rate of return earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity, and that all coupon and principal payments...
is the IRR on the bond's cash flows: the purchase price, the coupons received and the principal at maturity.
The yield to call is the IRR on the bond's cash flows, assuming it is called at the first opportunity, instead of being held till maturity.
The yield of a bond is inversely related to its price today: if the price of a bond falls, its yield goes up. Conversely, if interest rates decline (the market yield declines), then the price of the bond should rise (all else being equal).
There is also TIPS (Treasury Inflation Protected Securities), also known as Inflation Linked fixed income. TIPS are sold by the US Treasury and have a "real yield". The bond or note's face value is adjusted upwards with the CPI-U, and a real yield is applied to the adjusted principal to let the investor always outperform the inflation rate and protect purchasing power. However, many economists believe that the CPI under-represents actual inflation. In the event of deflation over the life of this type of fixed income, TIPS still mature at the price at which they were sold (initial face). Losing money on TIPS if bought at the initial auction and held to maturity is not possible even if deflation was long lasting.
Preferred shares
Like bonds, preferred shares compensate owners with scheduled payments. The payments are usually called dividends, although they may technically be considered interest.The dividend yield is the total yearly payments divided by the principal value of the preferred share.
The current yield
Current yield
The current yield, interest yield, income yield, flat yield or running yield is a financial term used in reference to bonds and other fixed-interest securities such as gilts...
is those same payments divided by the preferred share's market price.
If the preferred share has a maturity (not always) there can also be a yield to maturity
Yield to maturity
The Yield to maturity or redemption yield of a bond or other fixed-interest security, such as gilts, is the internal rate of return earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity, and that all coupon and principal payments...
and yield to call calculated, the same way as for bonds.
Preferred trust units
Like preferred shares but units in a trust. Trusts have certain tax advantages to standard corporations and are typically deemed to be "flow-through" vehicles. Private mutual funds trusts are gaining in popularity in Canada following the changes to tax legislation which forced many publicly traded royalty trustRoyalty trust
A royalty trust is a type of corporation, mostly in the United States or Canada, usually involved in oil and gas production or mining. However, unlike most corporations, its profits are not taxed at the corporate level provided a certain high percentage of profits are distributed to shareholders...
s to convert back into corporations. Investors seeking the high yields typically associated with the energy royalty trusts are increasingly investing in private mutual energy fund trusts.
Common shares
Common shares will often pay out a portion of the earnings as dividends. The dividend yieldDividend yield
The dividend yield or the dividend-price ratio on a company stock is the company's total annual dividend payments divided by its market capitalization, or the dividend per share, divided by the price per share. It is often expressed as a percentage...
is the total dollars (Yen, etc.) paid in a year divided by the spot price of the shares. Most web sites and reports are updated with the expected future year's payments, not the past year's.
The price/earnings ratio quoted for common shares is the reciprocal of what is called the earnings yield
Earnings yield
Earnings yield is the quotient of earnings per share divided by the share price. It is the reciprocal of the P/E ratio.The earnings yield is quoted as a percentage, allowing an easy comparison to going bond rates.-Applications:...
. EarningsPerShare / SharePrice.
Annuities
The life annuities purchased to fund retirement pay out a higher yield than can be obtained with other instruments, because part of the payment comes from a return of capitalReturn of capital
Return of capital refers to payments back to "capital owners" that exceed the growth of a business. It should not be confused with return on capital which measures a 'rate of return'....
. $YearlyDistribution / $CostOfContract.
REITs, royalty trust, income trusts
Like annuities, distribution yields from REITsReal estate investment trust
A real estate investment trust or REIT is a tax designation for a corporate entity investing in real estate. The purpose of this designation is to reduce or eliminate corporate tax. In return, REITs are required to distribute 90% of their taxable income into the hands of investors...
, Royalty trusts, and Income trusts often include cash that exceeds the income earned: that is return of capital
Return of capital
Return of capital refers to payments back to "capital owners" that exceed the growth of a business. It should not be confused with return on capital which measures a 'rate of return'....
. $YearlyDistribution / $SharePrice.
How to evaluate the yield (%)
All financial instruments compete with each other in the market place. Yield is one part of the total return of holding a security. A higher yield allows the owner to recoup his investment sooner, and so lessens risk. But on the other hand, a high yield may have resulted from a falling market value for the security as a result of higher risk.Yield levels vary mainly with expectations of inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
. Fears of high inflation in the future mean that investors ask for high yield (a low price vs the coupon) today.
The maturity of the instrument is one of the elements that determines risk
Risk
Risk is the potential that a chosen action or activity will lead to a loss . The notion implies that a choice having an influence on the outcome exists . Potential losses themselves may also be called "risks"...
. The relationship between yields and the maturity of instruments of similar credit worthiness, is described by the yield curve
Yield curve
In finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...
. Long dated instruments typically have a higher yield than short dated instruments.
The yield of a debt instrument is generally linked to the credit worthiness and default
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
probability of the issuer. The more the default risk, the higher the yield would be in most of the cases since issuers need to offer investors some compensation for the risk.
See also
- Ecological yieldEcological yieldEcological yield is the harvestable population growth of an ecosystem. It is most commonly measured in forestry;sustainable forestry is defined as that which does not harvest more wood in a year than has grown in that year, within a given patch of forest....
- Yield curveYield curveIn finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...
- 30-day yield30-day yieldIn the United States, 30-day yield is a standardized yield calculation for bond funds. The formula for calculating 30-day yield is specified by the U.S. Securities and Exchange Commission . The formula translates the bond fund's current portfolio income into a standardized yield for reporting and...
- 7 Day SEC Yield7 Day SEC YieldThe 7-day SEC yield is a measure of performance in the interest rates of money market mutual funds offered by US mutual fund companies.The calculation is performed as follows:This does not take compounding into effect.-Examples:...
- Nominal yieldNominal yieldNominal yield or coupon yield is the coupon rate of a fixed income security, which is a fixed percentage of the par value. Unlike current yield, it does not vary with the market price of the security....
- Bond (finance)Bond (finance)In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...