Yield
The term "yield" relates to a certain amount of earnings obtained from a specific investment over a specific time period. Yield may be classified as known or anticipated, and include interest or dividends received from holding a particular security. The yield on investment is calculated by dividing the dividend, coupon, or net income by the value of the investment, and is expressed as a percentage per year. The indicator of yield gives the investor information about how much income he can receive during the year in relation to the current market value or the initial cost of invested funds. Thus, the average yield on S&P 500 index stocks ranges from 2 to 4%. As with investments, the yield can also be obtained in any commercial firm.
Yield explained
Most often, the yield refers to instruments such as bonds and stocks and is expressed as a percentage of the value of the security. Yield is a kind of annual cash flow which is returned to the investor. Main factors that affect the yield on a security include dividends or changes in the price of a security.
Yield tracking is important, despite investors' preference for stock dividends. A sharp increase in yield can be an indicator of a decrease in the price of a share due to some circumstances or a company paying high dividends. An increase in the share price may result from the payment of higher dividends, due to the growth of the company's profit, which also means a yield increase.
Often, the higher the return value, the higher the amount of cash flows from their investments the investor will receive, however, it is worth considering the fact that too high a value can be an indicator of too high risk. A high yield can result from a fall in the market value of a security, and this reduces the value of the denominator and increases the estimated value of the return, even if the valuation of the security falls.
How to calculate Yield
So, yield is an indicator that determines the cash flow received by an investor from a security. Most often, its calculation is made on an annual basis, although other periodicity also take place, for example, the yield calculation once a quarter or a month. Yield differs from total return, which is a broader measure of return on investment. The following formula is used to calculate the yield: to get this figure, an investor needs to divide net realized return by principal amount.
As an example, an investor bought a stock at the price of $200 and later sold it for $250. In addition, he received a dividend of $10 per share for the year. The yield on this security will be equal to the sum of the increase in the value of this share and the dividends received divided by the initial price of the asset. As a result, we get the following yield: ($50 + $10) / $200 = 0.3, or 30%.
Yield types
There are several factors that affect the yield, these are the nature of the security, the duration of the investment and the amount of return that will be received. Based on the type of security, there are different ways to obtain the asset yield.
Yield on stocks. Two types of calculations are popular among investors. To determine the stock yield according to the first method, it is necessary to add an increase in the value of the security to the dividends on it, and then divide the resulting amount by the buying price. This is called yield on cost (YOC) also known as cost yield. So, If an investor fixed a profit of $50 ($250 - $200) as a result of price increase, and obtained $10 as a dividend from the company, the cost yield is ($50 + $10) / $200 = 0.3, or 30%.
But some investors prefer to calculate the yield using the second method, relying on the current market price rather than the purchase price of the asset. This type of yield is called the current yield. To determine the stock yield according to the second method, it is necessary to add an increase in the value of the security to the dividends on it, and then divide the resulting amount by the current price. The current yield is ($50 + $10) / $250 = 0.24, or 24%.
As the value of a stock rises, its current yield may show a decline due to the inverse relationship between yield and stock price.
Yield on bonds. For bonds with annual interest, the yield is called nominal yield. To determine the nominal yield, it is necessary to divide the annual interest of a bond by its face value. If a face value of a bond is $1,000, its maturity date is 1 year and annual interest equals to 10%, the nominal yield is $100 / $1,000 = 0.1 or 10%.
For floating interest rate bonds, the yield will vary over the life of the bond based on the applicable interest rate on different terms.
If a bond has interest based on the 10-year Treasury yield + 2% then its applicable interest will be 3% when the 10-year Treasury yield is 1% and will change to 4% if the 10-year Treasury yield increases to 2% after a few months.
Yield to maturity. In the case of holding a bond to maturity, a special index of the total return expected from the bond per year is calculated — yield to maturity (YTM). This figure may change from year to year. YTM is the expected average annual yield, and it is assumed to remain constant throughout the holding period until the bond matures.
Yield to worst. The indicator of the lowest potential yield is yield to worst (YTW) that can be obtained from a bond without the possibility of default by the issuer. YTW reflects the worst-case scenario for the bond. This yield shows an important measure of risk and provides assurance that certain return requirements will be met even under worst-case scenarios.
Yield to call. The yield to call (YTC) is a measure linked to a callable bond YTC refers to the bond’s yield at the time of its call date and is expressed as the interest paid on the bond, its market price, and the duration to the call date.
Other types. Bonds that are issued by a particular state, county or municipality — municipal bonds — to finance costs and most often tax-free have their own yield, also have a tax-equivalent yield (TEY).
The Securities and Exchange Commission (SEC) has developed a yield calculation method called the SEC yield that aims to more fairly value and compare bond funds.
Mutual fund yield is used to determine the net income of mutual funds. This figure can be obtained by dividing the annual income distribution payment by the value of mutual fund shares. The figure consists of dividend and interest income during a given year. This yield is calculated and changes based on the market value of the fund every day because mutual fund valuations change every day based on the estimated net asset value.
