Ch13 - Yield vs Interest rates

HI

I thought I understood this, but I keep on running into trouble when answering questions on this topic. So I would like to make sure I understand this correctly since it seems to come up frequently in the exams.

So my question basically is - what is the difference between yields and interest rates?

For a long time I thought that they are essentially the same thing. But I keep on getting the questions wrong. So please help!

This is my understanding so far:

Interest rate = is the return that can be earned on an asset invested?

Yield = expected income (i.e. return) / price of an asset

eg. Bonds (running yield) = coupon / price = GRY
Equity (dividend yield) = dividend / share price
Property (rental yield) = rental income (net of all management expenses) / property price (i.e. cost of buying property gross of all purchase expenses)

So does this mean that yields and interest rates are inversely related?

Also, is the following assumption in general correct:

GRY > rental yield > gross dividend yield (Ch.16 p.4)

Thank you!!

 

1) There is a difference between running yield and gross redemption yield. those 4 formulae are for running yields on bonds, equity and properties.
also running yield=income from asset/asset price

2) the gross redemption yield is what you would expect to get from an asset if you held it to maturity( in case of bonds) and assuming you hold it for life(in case of property and equities). But since you assume that you hold property and equity for life, we consider only their running yields as they have no maturity value.
running yield is not equal to gry as you have said.
gry is the effective interest rate you expect to get from a bond held to maturity.

3)GRY will be closely related to short and long term interest rates as they represent your return on asset which should be positively correlated with interest rates in general. price is inversely related to gry/interest rates as if you want a better expected return from an asset you should have to pay less for it today and conversely.

4) Gry would be higher than both rental yield and dividend yield as total return from properties and equity would also include capital gain. Usually rental yields would be higher than dividend yields but the comparison still depends on various other factors.

Do post in case of quries

 

Thank you for your comments!!

So GRY is the effective return on a bond held to maturity
- So this is effectively the same as the interest rate of return on the bond (i.e. i = GRY) ?
- does GRY include the capital redemption payment?
- and the running yield calculation on a bond only includes the coupon income?

So if GRY includes the capital redemption then I better understand why GRY > rental yield > dividend yield.

And then, for total return this would be different as the capital gain expected on the property and equity assets should exceed GRY on bonds? Is that correct?

Hope I am not confusing this matter even further...

Thanks for the help!

 

1) yes gry is the effective interest rate you would earn on a bond.
2) yes. Gry includes both capital redemption and the coupon payments and only the capital redemption in case of zero coupon bonds.
3) yes. The running yield is equal to coupon /price.
4) correct. Gry includes both coupon and redemption payments I.e it's the total return from a bond whereas rental yield and dividend yield only represent the running yields and not the total return.
5) not entirely correct. Capital gain + running yield should exceed gry on bonds. But the actual comparison will depend on the risk and investment characteristics of the bond equity or property in consideration. For eg the total return expected on a blue chip stock may be actually lower than say a very risky corporate bond


You are not! Again do post in case of queries

 

YES finally getting this!!!!!!

Thanks for the help Venkatesh!