In finance and investing, “yield” refers to the income generated by an investment over a certain period of time.
This is typically expressed as a percentage of the investment’s cost or current market value.
It’s essentially the return on an investment, usually expressed on an annual basis.
There are various types of yields, depending on the type of investment:
- Bond Yield: In the context of bonds, yield is the rate of return paid on the bond’s face value (or par value). The most commonly referred to yield for a bond is the annual interest payment divided by the current market price. This is known as the current yield.
- Dividend Yield: In the case of stocks, the dividend yield is the annual dividend payment divided by the stock’s current market price. For example, if a company’s annual dividend is $1 and the stock trades at $20, the dividend yield is 5%.
- Yield to Maturity (YTM): This is the total yield an investor will receive by holding a bond until it matures. YTM takes into account both the interest payments received annually and any capital gain or loss that will be realized by holding the bond until maturity.
- Yield on Cost: This yield calculation takes the annual income from an investment and divides it by the original cost of the investment.
Bond Yield: The Good Old Faithful
Imagine bonds as that loyal friend who always got your back, consistently paying you back a slice of your investment.
The bond yield is like a thank-you note for trusting them with your hard-earned cash. It’s the return rate paid on the bond’s face value (or par value). This is the “current yield.”
Let’s say you bought a bond with a face value of $1,000, and it pays an annual interest (also known as the coupon) of $50.
That gives you a current yield of 5% ($50/$1,000*100). Now, you’re not going to get filthy rich with that, but at least it’ll help pay for your Netflix subscription!
Dividend Yield: The Gift that Keeps on Giving
Next, let’s turn to stocks. If bonds are your loyal friends, consider dividend stocks as the generous uncle in your investment family.
The dividend yield is the annual dividend payment divided by the stock’s market price.
If a company’s annual dividend is $2 and the stock trades at $40, your dividend yield is 5% ($2/$40*100).
That’s like getting a birthday present every year, even when it’s not your birthday. Talk about having your cake and eating it too!
Yield to Maturity (YTM): The Long Game
Then we have the yield to maturity (YTM) – the total yield you’ll get by holding a bond until it matures.
Picture it as sticking to a fitness regime; it’s tough, but the end results are rewarding.
YTM takes into account both the interest payments received annually and any capital gain or loss that will be realized by holding the bond until maturity.
So, if you bought a bond at a discount of $900 that will mature to $1,000 in 10 years, and it pays an annual coupon of $40, your YTM would be higher than the current yield because you’re also making a $100 profit when the bond matures. Sweet deal, right?
Yield on Cost: Keeping Score
Finally, there’s yield on cost, which compares the annual income from an investment to the original cost.
This yield type is like keeping score; it shows you how well your investment has performed over time relative to what you originally paid.
If you bought a stock for $10 a share and it pays a $1 annual dividend, your yield on cost is 10%.
But if the stock price doubles to $20 and the company keeps the dividend steady at $1, your dividend yield drops to 5%, but your yield on cost remains at a glorious 10%.
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