In finance, the yield on a security is the income earned from an investment over a given period of time that is returned to the owners of the security in the form of interest or dividend payments received from it. It is often linked to fixed income investments where the return is known with reasonably certainty in advance.
A yield is one of two ways in which an investor can earn money. The other being the sale of the asset. It does not include the price variations which distinguishes it from the total return. It is important that traders understand how dividend payments can affect the profitability of merger arbitrage.
Yield may be considered known or anticipated depending on the security in question, as various securities experience fluctuations in value. Usually, the calculation will be expressed as a yearly percentage rate of either the value of the original investment, its current market value or its face value. The yield is forward looking measure, the income is taken in the context of a specific period and then annualized assuming the interest or dividends will continue to be received at the same rate.
Bond yields such as T-bills, convertible bonds or junk bonds can have multiple yield options depending on the exact nature of the investment. Therefore, this figure may differ to the annualized return. We advise readers to research these investment options directly for more in depth analysis. The coupon is the fixed bond interest rate fixed when the bond is issued.
- The coupon rate is the yield paid by fixed-income security. This rate is the annual coupon payment paid by the issuer relative to the face value (par value) of the bond
- The current yield is the bond interest rate as a percentage of the current price of the bond
- The yield to maturity is an estimate of what an investor will receive in coupons and capital gains if the bond is held to maturity
Yield Calculation Example
Yield is a measure of cash flow that an investor gets on the amount invested in a security. It is calculated as:
Yield = Income Received / Principal Amount
For example, gains and return on a stock investment can come as a rise in price, or the collection of a dividend. Let’s assume the stocks pays a $2 dividend quarterly, and the current price is $100. If, after one year the stock has risen to $120, the dividend yield for the example would be:
(4 x $2) / $100 = 0.08 or 8%
Note how this calculation does NOT include the change in price of the underlying asset. Traders may choose to use an average price throughout the year, or at the end of the period update the principal amount to $120 however.
