Effective Yield

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DEFINITION of 'Effective Yield'

The yield of a bond, assuming that you reinvest the coupon (interest payments) once you have received payment. Effective yield is the total yield an investor receives in relation to the nominal yield or coupon of a bond. Effective yield takes into account the power of compounding on investment returns, while nominal yield does not.

INVESTOPEDIA EXPLAINS 'Effective Yield'

For example, if an investor holds a bond that pays a 5% coupon semi-annually, he will actually receive two coupon payments per annum. If the investor reinvests each coupon payment then his effective yield will be greater than the stated coupon rate or nominal yield. Reinvesting the coupon will produce a higher yield, because interest is earned on the interest payments.

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