An important feature of many types of financial analysis is the yield. This term can have multiple specific meanings, but generally it means the income received on a principal. For instance, a fund that pays investors $3 every year per every $100 invested has a yield of 3%.
Yields can refer to dividends (in the case of stocks), distributions (in the case of funds), and coupon payments (in the case of bonds). The difference between these three terms isn’t too important for understanding the yield, as the same calculation is at play: income dividend by principal.
These inputs will vary according to changes in the market, and those changes vary between stocks, funds, and bonds. One common theme in all three: prices and yields are inversely proportional. A $3 payout on a $100 priced asset is 3%, but if that asset goes up to $120, suddenly the yield is 2.5%.
In bonds, different types of yields are often analyzed. There is yield to call, yield to worst, and yield to maturity. YTM is the easiest to understand, although there isn’t a single formula to calculate it precisely (a formula called the Newton’s method is used, but an online calculator will suffice for most purposes). All you need to know is the bond’s par value (i.e., its initial price and redemption value), its current market price, the annual coupon rate, and when it matures. This will tell you the real yield if the bond is held to maturity and not redeemed.
For yield to call, this refers to the yield on the bond until the bond is called—a term for when bondholders can decided to prepay their debt and terminate the bond (not all bonds are callable). The formula is a bit too complicated to discuss here, but you can see it on Investopedia. What is important is to know how to calculate this yield and to determine when (or if) a bond is callable.
Finally, there is yield to worst. This is the lowest possible yield that you can get on a bond without it defaulting. This formula is used for bonds that have multiple call dates (i.e., a bond that is callable more than once) and other prepayment provisions. The details of each bond will change the formula requires for a YTW calculation, but most bond terminals will show YTW data alongside information such as current price and coupon.
Understanding these different yields and how they are used is essential to identifying income flows and ensuring that an income investment pays what is expected. While yields are more important in some financial transactions than others, being aware of how cash flows work and are calculated is important for all financiers in all positions.