Financial Markets For The Rest Of Us|
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
You can now begin to see two distinct pieces in this example. The original investment, called the principal, and the yield. You, as many others,may be tempted to think that the yield is the same concept as the interest. While this may be true under some conditions, the yield is usually a different value than the interest, although it is based on the interest. As you could clearly see, changing the compounding period from annual to semi-annual gave you an extra $10 in yield. The interest is a fixed value attached to an investment (in our example 20%), while the yield can change due to factors such as the compounding period and the value of the underlying principal. The yield in percentage terms is calculated by dividing the gain (profit) by the principal.
Yield = Gain / Principal
Let's take a look at our example again. The interest on the savings account is a fixed 20%. The yield, however, for semiannual compounding is
Yield = 210 / 1000 = 0.21 or 21%
The yield in our example would increase as the compounding period decreases (i.e., the compounding frequency increases). The yield represents the true gain on an investment while the interest is the underlying percentage gain assigned to that investment at its inception.
Another way that the yield on an investment can be affected is if the value of the underlying principal changes. Let's look at another example. Suppose that instead of the savings account in our last example you invest $1,000 in another type of account which pays a one-time 20% interest on your money after one year but requires you to lock in your deposit for the full year. If you leave your money in this account for the entire year, the return on your investment will be $200 which …
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