Yield vs. Interest Rate: What's the Difference?

Yield vs. Interest Rate: An Overview

Both yield and interest rates are important terms for any investor to understand, especially those investors with fixed income securities such as bonds or CDs.

Yield refers to the earnings from an investment over a specific period. It includes investor earnings, such as interest and dividends received by holding particular investments. Yield is also the annual profit that an investor receives for an investment.

The interest rate is the percentage charged by a lender for a loan. Interest rate is also used to describe the amount of regular return an investor can expect from a debt instrument such as a bond or certificate of deposit (CD). Ultimately, interest rates are reflected in the yield that an investor in debt can expect to earn.

Key Takeaways

• Yield is the annual net profit that an investor earns on an investment.
• The interest rate is the percentage charged by a lender for a loan.
• The yield on new investments in debt of any kind reflects interest rates at the time they are issued.

Yield

Yield refers to the return that an investor receives from an investment such as a stock or a bond. It is usually reported as an annual figure. In bonds, as in any investment in debt, the yield is comprised of payments of interest known as the coupon.

In stocks, the term yield does not refer to profit from the sale of shares. It indicates the return in dividends for those who hold the shares. Dividends are the investor's share of the company's quarterly profit.

For example, if PepsiCo (PEP) pays its shareholders a quarterly dividend of 50 cents and the stock price is $50, the annual dividend yield would be 4%. If the stock price doubles to$100 and the dividend remains the same, then the yield is reduced to 2%.

In bonds, the yield is expressed as yield-to-maturity (YTM). The yield-to-maturity of a bond is the total return that the bond's holder can expect to receive by the time the bond matures. The yield is based on the interest rate that the bond issuer agrees to pay.

Interest Rates

The interest rate on any loan is the percentage of the principle that a lender will charge annually until the loan is repaid. In consumer lending, it is typically expressed as the annual percentage rate (APR) of the loan.

Special Considerations

Current interest rates underpin the yield on all borrowing, from consumer loans to mortgages and bonds. They also determine how much an individual makes for saving money, whether in a simple savings account, a CD, or an investment-quality bond.

The current interest rate determines the yield that a bond will bear at the time it is issued. It also determines the yield a bank will demand when a consumer seeks a new car loan. The precise rates will vary, of course, depending on how much the bond issuer or the bank lender wants the business and the creditworthiness of the borrower.

Interest rates constantly fluctuate, with the most important factor being the guidance of the Federal Reserve, which periodically issues a target range for a key interest rate. All other lending rates are essentially extrapolated from that key interest rate.

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1. Board of Governors of the Federal Reserve System. "Open Market Operations."

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