How to compute yield on bond, FD and Stock?
Last week there were a few queries from readers on how to compute yield on a bond or FD scheme or Stock. The answer is not same for all such investment options. We know simple interest, we all know compounding interest, but what is this yield ? How to calculate yield on an investment option?
What is Yield and how to compute yield?
Annualised yield is the interest or dividend received in a year over the total investment done.
Total Yield is the simple math of what is received as a return against the investment amount divided by investment and number of years.
Yield = Total yield received / total number of years
Let me explain this with an example. If you invested Rs 10,000 for 2 years and received interest of Rs 1,000 on an investment for 2 years put together, it means the yield is 5% (Rs 1,000/Rs 10,000 x 2)
How to compute yield of Stock?
Dividends are paid by companies based on company performance. Though they say they are declaring 50% dividend, in reality what you compute is not 50% straight.
Yield of a stock = Dividend received / Stock price x 100
Let me explain this with an example
Share price of X company is Rs 300 and they declared dividend of 50% on face value of Rs 10 per share. Means they declared Rs 5 as dividend for every share. Rs 5 on share price of Rs 300 comes to 1.67%. This is called as dividend yield on a stock.
How to compute yield on FD scheme?
When you invest in FD scheme, it gives interest per annum. It could be compounded quarterly, half-yearly or annually. The yield is a simple computation of what is received divided by the total number of years invested. E.g. FD scheme has been offering 12% annualized returns for 3 years. Interest rates are compounded annually. If you invest Rs 10,000 in such FD Scheme @ 12% interest, yield is computed as below
Interest on first year = Rs 10,000 x 12% = Rs 1200
Interest on second year = Rs 11,200 (Rs 10,000 principal and Rs 1,200 of interest of first year) x 12% = Rs 1,344
Interest for third year = Rs 12,544 (Rs 10,000 principal and Rs 2,544 interest of first and second year) x 12% = Rs 1,505
Total interest received = Rs 4,049 on an investment of Rs 10,000.
Yield = Rs 4,049 / 10,000 / 3 x 100 = 13.50% per annum.
How to calculate yield on bonds?
Now let us come to the tricky part on how to compute yield on bonds. Though the math seems simple, the computation is performed based on coupon rate and current bond prices.
Yield of a bond = Coupon amount / Bond price x 100
For an example, if a bond price of Rs 1,000 has a coupon rate of 9%, you would get the coupon amount of Rs 90 per annum and here it what it looks at different scenarios
a) Scenario –No change in bond prices:
Normal Yield = 9%
b) Scenario – Bond prices decreases from Rs 1,000 to Rs 900, however you would still get coupon rate of 9% on original bond price.
Yield = Rs 90 (Coupon amount) / Rs 900 (current bond price) x 100 = 10%
c) Scenario – Bond prices increases from Rs 1,000 to Rs 1,100. You would still get Rs 90 as coupon amount as it is based on original bond price
Yield = Rs 90 / Rs 1100 x 100 = 8.2%
Means, bonds provide increased yield when bond prices fall and they would provide a low yield when bond prices increase.
Conclusion: When RBI increases interest rates, bond prices would fall and yield increases and vice versa. Knowing how to compute yield on a bond or FD or stock would help you to be aware of where to invest and how such yield would increase or decrease in various economic conditions.
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How to compute yield on bond, FD and Stock