You have often heard about ‘yield’ on bonds, stocks or mutual fund units but may have probably wondered what it means and what does it signify. Simply put, yield is the return on investment in the form of dividend or interest income and it is expressed as an annualised percentage based on the cost price, face value or current market price of the investment.
The yield on a stock or a mutual fund (MF) scheme is expressed as ‘dividend yield’, while the yield on bonds is expressed in terms of ‘interest yield’ (or ‘bond yield’). The dividend yield can be calculated based on cost (acquisition) price or the current market price (CMP). For example, if the cost price of a stock (or MF unit) bought in 2015 was Rs 50 and the dividend for the last financial year is Rs 5 per share (or per MF unit), the dividend yield is 10% (5/50x100=10%). However, if the market price of the stock or MF unit has gone up and it is currently quoting at Rs 55, the dividend yield on the CMP would be 9.09% approx. If the shares or MF units were bought in an IPO or NFO at Rs 10, the dividend yield would be a whopping 50%.
In the case of bonds, the interest (or bond) yield would depend on the coupon rate of the bond and the current market price of the bond. The coupon rate is the rate of interest fixed at the time of issuance of the bond. Since the interest rate on the bond remains fixed, any fluctuation in the market interest rates affects the bond yield positively or negatively. For example, if the coupon rate of bond is 10% and the current market price of the bond (with issue price of Rs 100) is Rs 103, the bond yield on the CMP would be 9.7% approx.
However, if the interest rates go up, the bondholder would be at a disadvantage as the coupon rate on the bond remains the same. As a result, the price of the bond would fall to maintain the same return yielded by prevailing interest rates. In the above example, the bond price would have to decline to Rs 101 to maintain the interest yield at 9.90% approx.