Yield: Definition, How to Calculate with Examples, & Types

Returns can be classified according to the type of security and sometimes, some peculiar factors we’ll see shortly.

For investments in stock, two types of returns are popularly known.

• Cost yield: This is gotten when the return is calculated based on the purchase price.

Cost Yield = (Price Increase + Dividends Paid) / Purchase Price

• Current yield: To calculate the return here, you use the current market price.

Current Yield = (Price Increase + Dividend Paid) / Current Price

When a company’s stock price increases, the current return decreases because of the inverse relationship between yield and stock price.

This is another type of return according to security.

There are bonds that pay annual interest. Their calculation is according to the nominal yield.

Nominal Yield = (Annual Interest Earned / Face Value of Bond)

For example, if there is a bond with a face value of $1,000 and maturity of one year and pays 5% annual interest. The return is $50 / $1,000 = 0.05 or 5%.

However, it is important to note that there are bonds with floating interest rates. Their returns change and are not steady over the life of the bond.

#3. Mutual Fund Yield

This represents the net income return of a mutual fund.

You calculate it by dividing the annual income paid by the value of a mutual fund’s shares.

It includes the income received through dividends and interest earned during the given year.

Since mutual fund valuation changes based on the daily net asset value, the mutual fund returns also vary with the fund’s daily market value.

#4. Yield to Maturity

Yield to maturity (YTM) is a particular measure of the annual total return on a bond if it is kept to maturity. It’s not to be confused with nominal yield, which is computed on a per-year basis and fluctuates with each passing year. YTM, on the other hand, is the predicted annual average yield, and the value is expected to remain constant throughout the holding term until the bond matures.

#5. Yield to Worst

The yield to worst (YTW) is a measure of the lowest possible yield on a bond that may be received without the issuer defaulting. YTW calculates the return that would be obtained if the issuer used provisions such as prepayments, callbacks, or sinking funds to calculate the worst-case scenario on the bond. This yield serves as a key risk indicator, ensuring that certain income requirements are met even in the worst-case situation.

#6. Yield to Call

The yield to call (YTC) is a measure associated with a callable bond—a type of bond that can be redeemed by the issuer before maturity—and refers to the bond’s yield at the call date. The bond’s interest payments, market price, and the length until the call date, which specifies the interest amount, all contribute to this value.

Meanwhile, municipal bonds, which are mainly non-taxable bonds issued by a state, municipality, or county to fund capital expenditures, also have a tax-equivalent yield (TEY). TEY is the pretax yield required for a taxable bond to have the same yield as a tax-free municipal bond, and it is determined by the investor’s tax bracket.

While there are tons of various ways to compute different types of yields, corporations, issuers, and fund managers have a lot of freedom to calculate, report, and market the yield value according to their own conventions.

But then regulators such as the Securities and Exchange Commission (SEC) have adopted a standard yield calculation known as the SEC yield. The SEC yield is a standard yield calculation produced by the SEC with the goal of providing a common metric for fairer bond fund comparisons. SEC yields are computed after the fund’s mandatory costs have been taken into account. 

Read Also: How to Spot High Yield Investments (Easy Guide)

Yield Example

Consider an investor who wishes to calculate the yield to worst on a bond as one way to analyze risk. This essentially gauges the lowest possible yield. First, the investor would determine the bond’s earliest callable date, which is the day on which the issuer must return principal and cease interest payments. After calculating this date, the investor would calculate the bond’s worst-case yield. As a result, while the yield to worst represents the return over a shorter time period, it represents a lesser return than the yield to maturity.

How to Calculate Yield?

It measures the cash flow an investor receives on the amount invested.

Generally, yield = dividends or interest received in a set period of time / amount originally invested or current price.

For a bond, for example, if you invest $900 in a $1,000 bond that pays a 5% coupon rate, your interest income would be ($1,000 x 5%) = $50. The current yield will be ($50)/($900) = 5.56%.

High return either in stocks or bonds can be the result of a falling market value of the security.

For a stock, there are two kinds of yields: the yield on cost, and current yield.

Yield on Cost = Div/Purchase Price and Current Yield = Div/Current Price

If an investor puts $100 into a stock that paid $1 as an annual dividend. The yield on cost is $1/$100 = 0.01 = 1%.

If the investment made $10 during the year, and its current yield is $1/$110 = 0.009 = 0.91%.

From the examples, we can conclude that if the stock price increases and the dividend remain the same, the current yield will be lower than when the stock was originally bought. This is because yields have an inverse relationship with the stock price.