What Is Yield ?
Yield is an economic indicator that illustrates the effectiveness of investments in various financial instruments, such as securities, company shares, bills, and bank deposits. It also indicates the profitability of an enterprise or business project. You can use yield to compare securities that are attractive for investment and choose the most profitable ones.
Yield is one of the main indicators of investments by which it is possible to evaluate the feasibility of investments and compare them by this indicator. Often, to assess if the investment is worth making, a combination of risk and yield is used. The logic here is simple: indicators such as profitability and risk by themselves are uninformative. What is the point of investing in instruments with a high level of risk and low yield potential? If the risk of losses is great, then the possible reward should be at a high level.
It is necessary to distinguish between income and yield meaning. Income is expressed in monetary terms and is an absolute value, while yield is a relative parameter, which is determined as a percentage of dividing profit by investment.
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Types of Yield on Bond Investments
An investor who buys a security receives income from coupon payments, price fluctuations, and reinvestment of funds received from coupon payments. All three sources of income represent cash income from owning a bond. To determine the interest income from the investment, traders and investors resort to the calculation of current yield, yield to maturity, and yield to early repayment.
Current Yield (CY)
The CY of the bond is comparable in meaning with the dividend yield, which is defined by dividing the amount of the dividend by the spot price of the stock. To obtain the CY, a similar formula is used:
CY = annual coupon in monetary terms / bond price * 100%
Note that if a bond is traded below the face value, then the CY will exceed the coupon rate. Conversely, when a bond is trading above face value, the CY will be below the coupon rate.
Yield to Maturity (YTM)
It is the rate of return on investment in bonds, provided that they are purchased before maturity. YTM can be calculated both considering the reinvestment of coupon payments during the year (effective yield), and without considering it (nominal yield, simple yield). It should be noted that the yield to maturity is only an estimation of how much the investor will receive by purchasing this bond, because the calculation of the YTM involves the reinvestment of coupons at the same interest rate. In reality, this assumption cannot be fulfilled, so the actual yield will differ from the estimated YTM. However, YTM is the most commonly used method of bond valuation.
Yield to Call (YTC)
YTC is the effective annual interest rate for a revocable bond calculated at the time of its possible early repayment. A revocable bond differs from an irrevocable one by the presence of two additional characteristics: the redemption price, which will be paid to the bondholder in the case of early redemption (this price is above par) and the term of protection against early repayment.
Such financial instruments have the following logic. A bond is an object of long-term financial investment when its holder plans to receive an agreed percentage for a long time. For the issuer, the interest paid represents constant financial expenses that they must bear for a long time regardless of its income. By announcing the interest rate at the time of issuing the bond loan, the issuer focuses on the average rate prevailing in the loan capital market. However, they risk to a certain extent, because if the market rates are reduced, it would be unprofitable for them to pay a higher percentage. Therefore, revocable bonds are issued subject to the possibility of early repayment initiated by the issuer.
What Is Dividend Yield
It is a key financial indicator that reflects the current share price ratio to the dividends paid on it. The end of each next payment is called a dividend cutoff. Such cutoffs help to keep track of the issuer's payment history and predict future dividends.
If you know what is dividend yield, you can easily determine which assets are more profitable to invest your finances. For example, securities of two different companies bring dividends in the amount of $100 for each. Moreover, each share of the first company costs $2,000 and the second - $4,000. Note that if the investment difference is 2 times, the dividend payments of both issuers are the same. So, a logical question arises: if you can get the same amount with a smaller amount of investment, why invest in less efficient expensive stocks?
As a rule, a company indicates the sources of dividends in its charter or dividend policy. All these sources typically come down to two main ones - the net profit of the company and / or its cash from the main activity after tax deductions and salary payments.
DY allows you to evaluate your long-term portfolio relative to other financial instruments. For example, you bought shares of company X for $100,000, and its DY is 7%. This allows you to be sure that you will receive your $7,000 in any case. Therefore, even if the value of the company’s shares drops, you will receive money in your bank account.
How to Calculate Dividend Yield
To get DY, divide the number of dividends that the company pays for the year by the value per share. The formula is as follows: (size of dividends per 1 share) / (cost of 1 share) * 100%
As the value of a share is constantly changing, the DY indicator will also change.
According to the formula, the higher the size of dividends, the higher the DY. Moreover, if the value of stocks increases, then the DY falls.
Dividend Yield in the UK
According to the article in Financial Times as of August 2019, the average dividend yield in the UK has hit its historic high during recent years. In 2018, the average yield rose to 4.8%, marking a 29-year high. Though it is expected to fall at 4.2% this year, it still remains well above the 30-year average of 3.5%.
Yield is a key financial indicator that shows how efficient are investments in different financial instruments. Unlike income, yield is a relative parameter, which is calculated as a percentage of dividing profit by investment.
Now you have an idea of what is yield and what is dividend yield. For more helpful information, visit Monfex.com.