LeoGlossary: Yield

The percentage return paid on a stock in the form of dividends, or the effective rate of interest paid on a bond or note.

This is something that often investors focus upon when selecting investments.

Yield is a different approach to investing as compared to those who engage in speculation. Individuals are most focused upon price appreciation as compared to the yield.

Yield investors make up the longest market. Bonds and other fixed income instruments provide the vehicle whereby participants can compound their returns while growing their wealth.

Factors

Yield instruments compete against other financial products in the open market. Investors have to weight the risk associated with owning one particular security over another. This is where the returns are weighed.

When the yield is higher, this allows the investor to recoup the money invested sooner, thus reduce the risk.

Yield in debt instruments tend to be related to credit rating. Companies that have a lower rating have to pay a higher return to entice investors to get involved. This is to offset the potential for default on the payment of principal and interest.

The flip side of this is risk-free yield which is provided by the 10-year U.S. Treasury. All fixed income investments are weighed against this metric.

Expectations in areas such as inflation can also impact yields. The same is true for the business cycle and state of the economy. In these times, investors will require higher yields.

The yield on a fixed income security is inversely related to interest rates. If rates rise, for example due to inflation or a change in the economy, the price of a bond or note falls, driving its yield higher to maintain parity with the market. The reverse also occurs. If market rates decline, then the price of the bond should increase, driving its yield lower.

Typically, the yield on the 10-year Treasury bond will be higher than short-term securities. Time in considered an important variable as it brings greater uncertainty. Longer term assets have more price volatility as a result.

Related:

See also: Yield Curve

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