Yield is the income generated and realized on an investment over a specific period of time, expressed as a percentage of the purchase price or current market value.
Understanding yield
Yield measures the cash flow an investor receives from an asset. The concept applies to different types of investments, including corporate bonds, government debt, dividend-paying stocks and commercial real estate. For debt instruments, the yield is the interest payment. For equities, the yield is the dividend payment. For property investments, the yield is the rental income collected from tenants.
The calculation of yield depends on the asset class and the specific financial metric an investor wants to evaluate. Current yield is a standard calculation used in fixed-income trading. It divides the annual income generated by the asset by the current market price of that asset. Because the income payout is often fixed, the yield moves inversely to the asset price. If a bond price increases on the open market, the current yield decreases. If the bond price drops, the current yield increases.
Yield is fundamentally different from total return. Total return includes the income generated by the yield along with any capital gains or losses resulting from changes in the market price of the asset. An investment can generate a high yield while simultaneously delivering a negative total return if the underlying asset loses significant market value. Elephants analyzing financial markets look at both yield and total return to evaluate the absolute performance of their portfolios.
Example
Suppose an Elephant purchases a corporate bond issued by a company that manufactures heavy-duty watering troughs for migrating herds. The Elephant buys the bond at a face value of 1,000. The trough manufacturer pays 50 in interest every year. The yield on this bond at the time of purchase is 5 percent, calculated by dividing the 50 annual income by the 1,000 purchase price. One year later, broader market interest rates rise, causing the price of the bond to drop to 800 on the secondary market. The company still pays the fixed 50 annual interest. The current yield for a new buyer is now 6.25 percent, calculated by dividing the 50 income by the 800 market price.