What is a return?

Return refers to the income generated and realized on an investment over a period of time. It is expressed as a percentage based on the amount invested, the current market value or the face value of the security.

Yield includes interest earned or dividends received from holding a particular security. Depending on the valuation (fixed or fluctuating) of the security, the returns can be classified as known or expected.

Yield Formula

Return is a measure of the cash flow that an investor gets on the amount invested in a security. It is mostly calculated on an annual basis, although other variations such as quarterly and monthly returns are also used. Return should not be confused with total return, which is a more comprehensive measure of return on investment. The yield is calculated as:

Return = Net realized return / Amount of capital

For example, earnings and returns from equity investments can take two forms. First, it can be in terms of rising prices, when an investor buys a stock for $ 100 a share and after a year sells it for $ 120. Second, the stock can pay a dividend, say $ 2 per share, during the year. The return would be the appreciation in the stock price plus dividends paid, divided by the original price of the stock. The yield for the example would be:

($ 20 + $ 2) / $ 100 = 0.22 or 22%

What the yield can tell you

Since a higher return value indicates that an investor is able to recoup higher amounts of cash flow from their investments, a higher value is often seen as an indicator of lower risk and higher income. Student. However, care must be taken to understand the calculations involved. A high return may have resulted from a decline in the market value of the security, which decreases the value of the denominator used in the formula and increases the calculated return value even when the valuations of the security are falling.

While many investors prefer dividends from stocks, it’s also important to keep an eye on returns. If the yields get too high, it could indicate that the stock price is falling or that the company is paying high dividends.

Since dividends are paid from company profits, higher dividend payouts could mean company profits are going up, which could cause stock prices to rise. Higher dividends with higher stock prices should lead to a constant or marginal increase in yield. However, a significant increase in yield without an increase in the stock price can mean the company is paying dividends without increasing profits, which can indicate short-term cash flow issues.

Types of returns

Returns may vary depending on the security invested, the length of the investment and the amount of the return.

Equity return

For equity investments, two types of returns are commonly used. When calculated on the basis of the purchase price, the return is called return on cost (YOC), or return on cost, and is calculated as follows:

Cost Return = (Price Increase + Dividends Paid) / Purchase Price

For example, if an investor made a profit of $ 20 ($ 120 – $ 100) from the price increase, and also earned $ 2 on a dividend paid by the company. Therefore, the cost return is ($ 20 + $ 2) / $ 100 = 0.22 or 22%.

However, many investors may wish to calculate the return based on the current market price, instead of the purchase price. This yield is called the current yield and is calculated as follows:

Current yield = (Price increase + Dividend paid) / Current price

For example, the current yield is ($ 20 + $ 2) / $ 120 = 0.1833, or 18.33%.

When a company’s stock price rises, the current return decreases due to the inverse relationship between return and stock price.

Bond yield

The yield on bonds that pay annual interest can be calculated in a simple way, called nominal yield, which is calculated as follows:

Nominal yield = (annual interest earned / nominal value of the bond)

For example, if there is a Treasury bond with a face value of $ 1,000 that matures in a year and pays 5% annual interest, its yield is calculated as: $ 50 / $ 1,000 = 0.05 or 5%.

However, the yield on a variable interest rate bond, which pays variable interest over its term, will change over the life of the bond depending on the interest rate applicable under different conditions.

If there is a bond that pays interest based on the 10-year Treasury yield + 2%, then its applicable interest will be 3% when the 10-year Treasury yield is 1% and will increase to 4% if the 10-year Treasury yield increases to 2% after a few months.

Likewise, interest earned on an index-linked bond, whose interest payments are adjusted based on an index, such as the Consumer Price Index (CPI) inflation index, will change accordingly. fluctuations in the value of the index.

The yield to maturity (YTM) is a special measure of the total expected return on a bond each year if the bond is held to maturity. It differs from the nominal return, which is usually calculated on an annual basis and is subject to change from year to year. On the other hand, YTM is the expected average return per year and the value is expected to remain constant throughout the holding period until maturity of the bond.

Return to Worst (YTW) is a measure of the lowest potential return that can be received on a bond without the possibility of issuer default. YTW indicates the worst-case scenario on the bond by calculating the return that would be received if the issuer used arrangements that included prepayments, callbacks, or sinking funds. This return is an important measure of risk and ensures that certain income requirements will always be met, even in worst-case scenarios.

Yield to call (YTC) is a measure linked to a callable bond – a special category of bonds that can be redeemed by the issuer before maturity – and YTC refers to the bond’s yield at the time of its due date. ‘call. This value is determined by the bond’s interest payments, its market price, and the term to the call date, as this period defines the amount of interest.

Municipal bonds, which are bonds issued by a state, municipality or county to finance its capital expenditures and are mostly non-taxable,sealso have a tax equivalent yield (TEY). TEY is the pre-tax return that a taxable bond must have in order for its return to be the same as that of a non-taxable municipal bond, and it is determined by the investor’s tax bracket.sese

Although there are many variations on how to calculate the different types of returns, companies, issuers and fund managers have a great deal of freedom to calculate, report and publish the value of the return according to their own conventions.

Regulators like the Securities and Exchange Commission (SEC) have introduced a standard measure for calculating yield, called the SEC yield, which is the standard yield calculation developed by the SEC and aims to offer a standard measure for fairer comparisons. bond funds. SEC returns are calculated after taking into consideration the required fees associated with the fund.sese

The mutual fund return is used to represent the net income of a mutual fund and is calculated by dividing the annual income distribution payment by the value of a mutual fund’s shares. It includes the income received in the form of dividends and interest that was earned by the fund portfolio during the given year. Since the valuation of mutual funds changes daily based on their calculated net asset value, the returns of mutual funds are also calculated and vary based on the market value of the fund each day.

In addition to investments, the return can also be calculated on any business venture. The calculation uses the form of the return generated on the invested capital.

Frequently Asked Questions

What is a return?

Return measures the return achieved on a security over a period of time. Typically, it applies to various bonds and stocks and is presented as a percentage of a security’s value. Key components that influence a security’s performance include dividends or a security’s price movements. The return represents the cash flow that is returned to the investor, usually expressed on an annual basis.

How is the return calculated?

To calculate the return, the net realized return on a security is divided by the capital. It is important to note that there are different ways to get the return on a security depending on the type of asset and the type of return. For example, for stocks, the return is calculated as the increase in the price of a security plus dividends divided by the purchase price. In contrast, the yield can be analyzed as the cost yield or the current yield for bonds. The cost return measures the return on the security’s original price, calculated as the price increase plus dividends paid divided by the purchase price. Current yield, on the other hand, measures the yield against the current price instead.

What is an example of performance?

As a measure of risk assessment, consider an investor who wants to calculate the worst return on a bond. Essentially, it measures the lowest possible return realized on a bond. First, the investor would find the bond’s earliest call date, the date on which the issuer must repay principal and stop interest payments. After determining this date, he would calculate the worst-case yield for the bond. Therefore, since the worst-case return is the return for a shorter period of time, it expresses a return that is less than the return to maturity.