A yield is defined as the earnings generated by an investment or security over a particular time period.
This is in typically displayed in percentage terms and is in the form of interest or dividends received from it.
Yields do not include the price variations, which differentiates it from the total return.
As such, a yield applies to various stated rates of return on stocks, fixed income instruments such as bonds, and other types of investment products.
Yields can be calculated as a ratio or as an internal rate of return, which may also be used to indicate the owner's total return, or portion of income, etc.
Understanding Yields in Finance
At any point in time, all financial instruments compete with each other in a given marketplace.
Analyzing yields is simply one metric and reflects a singular part of the total return of holding a security.
For example, a higher yield allows the owner to recoup his investment sooner, and thus mitigates risk.
Conversely, a high yield may have resulted from a falling market value for the security as a result of higher risk. Yield levels are also dictated by expectations of inflation.
Indeed, fears of higher levels of inflation in the future suggest that investors would ask for high yield or a lower price versus the coupon today.
The maturity of the instrument is also one of the elements that determines risk.
The relationship between yields and the maturity of instruments of similar credit worthiness, is described by the yield curve.
Overall, long dated instruments typically have a higher yield than short dated instruments.
The yield of a debt instrument is typically linked to the credit worthiness and default probability of the issuer.
Consequently, the more the default risk, the higher the yield would be in most of the cases since issuers need to offer investors some compensation for the risk.