Yield
Yield refers to the amount of income (dividends or interest) that an investment is expected to pay out over a period of time, most commonly a year. While returns measure the money that you have made on an investment, a yield is the money that you expect to make on an investment. We will cover several different types of yields so that you are able to handle exam questions that combine information on yield and returns.
Nominal yield is the percentage of the face value of a security (the amount at which the bond will be redeemed) that is paid out on the security. The nominal yield is also called the coupon rate. The nominal yield and face value of the bond do not change over time. Nominal yield is primarily used for fixed income securities.
For example, a bond that pays $70 per year and has a face value of $1,000 would have a nominal yield of 7% (7% = $70 / $1,000). Similarly, a bond with a coupon rate of 5% would pay annual interest of $50 (0.05 x $1,000 = $50).
Bonds typically have a face value of $1,000, meaning they pay out a principal of $1,000 at maturity. But a bond is often traded at either a premium (e.g., $1,100) or a discount (e.g., $980) to its face value. A bond’s current yield incorporates whether the bond was purchased at either a premium or discount and reflects this additional gain or loss. A bond that is purchased at a discount will have a higher current yield than a bond with the same nominal yield purchased at a premium.
Current yield is calculated by dividing the annual interest paid on the bond by the purchase price of the security. Remember, the basic formula for current yield is:
For example, a bond that pays a 5% coupon rate, or $50 per year, and was purchased for $900 would have a yield of 5.6% (5.6% = $50 / $900).
The concept of current yield can also be applied to equities and is calculated in the following manner:
However, because equity div