Yield Management: Definition, Formula, How to Evaluate, Types

Definition of Yield Management: It refers to the returns or total revenue generated and received on an investment over a specific period. It can be expressed as the percentage value depending on the investment money, face value of an asset or present market value. It includes the amount of interest gained or dividends earned from holding a particular asset. Yields can be classified into two types, either known or anticipated depending on the estimation (fluctuating vs fixed).

More simply, one can express it as the dividends paid and calculated as the net received return divided by the amount invested or principal amount. Higher yield is considered as a tool which reflects the higher income and lower risk. But a large yield may not always be positive in cases where dividend yield rises due to sliding share price.

The price variation is the only factor which distinguishes the yield from the total return. Generally, yield does not include price variation. It applies to different mentioned rates of revenues on shares ( preferred, standard and convertible), static income tools (notes, bonds, bills, zero-coupon, strips) and some other insurance products ( such as annuities) for investment.

This word is used in several conditions for reflecting different things. It can be calculated as a ratio or as an internal rate of return (IRR). Sometimes it also reflects the total revenue of the investor, or a small portion of his income, or his excess income.

The Formula For Yield Calculation

It is a measure of the flow of cash that a trader gets on the total amount invested on an asset. It is mostly calculated every year, though other yield variations such as monthly and quarterly are also popular. The total return is a more comprehensive measure for calculating revenues on investment. So, one should not get confused with this word. The formula for yield is:

Yield = Net return received/ Principal Amount

How To Evaluate The Yield Management

All monetary tools compete with each other in the financial market. Yield is just one part of the total revenue generated by holding an asset. The higher yield tells an investor to regain his investment soon, thus reducing the risk. But care must be taken before regaining because sometimes high yield results from decreasing market value (due to high risk) of an asset.

Mainly the level of yield varies with the expectations of inflation. If the investor demands high yield at present, then the fear of steep inflation increases in the future.

The maturity of an instrument is the crucial element that defines the risk. The yield curve shows the relationship between the maturity of instruments (of same creditworthiness) and yield generated. Long-dated tools generally have a higher return in comparison to the short-dated tools.

Types of Yield Management

The factor responsible for varying the yields included duration of investment, the revenue amount and the invested security.

It is broadly categorised into two parts yield on stocks and yield on bonds, notes and bills.

Yield on Stocks

The stock investments two types of yield are commonly used. When one calculates yield by taking purchasing price as a base, then it is known as the yield on cost (YOC) and is calculated by:

Cost yield = (Dividends paid + price increase) / purchasing price

The Yield on Bonds, Notes and Bills

The nominal rate or the coupon rate is the annual aggregate of interest or coupons paid divided by the face (principal) value of the bond.

The current yield is the ratio of all payments to that of spot market price of bonds.

The yield to maturity (YTC) is the internal rate of return on the bond’s cash flows, including principal at maturity, coupons received and the purchase price of the security.

The yield to call is a measure connected to a callable bond (it is a particular type of bond that can be retrieved by the issuer before its maturity). YTC refers to the yield at the time of the call date. It is calculated by using interest payments, the market price of a bond and its duration.