June 06 , 2012
Consider a bond paying 8% interest every year. This gives a fair picture of what it returns. But consider another that pays 30% interest, but only at the end of five years. How do you compare this with the first bond? Thus, interest as a parameter is inadequate to see what a bond returns. This is what brings us the concept of yield.
Yield is simply what you get as return from a bond in one year, for every Rs.100 invested. This may or may not be actually paid to you every year, as seen in the example above. In computing yield, we see what the payment from the bond effectively amounts to, on an annual basis. Importantly, this conversion is based on annual compounding, not simple interest. This makes yield the most accurate number to study in a bond.