What is the difference between interest rate and yield?

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What is the difference between interest rate and yield?
Though misunderstood to be same on different grounds, there exists a slight difference between interest rates and yield. Often, financial institutions and companies highlight the likely yield from an investment as it comes out be higher than interest rates in order to lure more and more investors. An attempt to provide the subtle difference between the two terms is done in the following article for investor's know-how :

 Interest rate : Interest rate is the return computed on the principal amount for any investment instrument such as fixed deposit, recurring deposit, PPF etc for different tenures. Simply put, the parameter stated in % terms produces the return over and above the initial investment amount. The tenet holds true both in case of credit or saving instrument.

 The interest rate indicating the probable return from an investment does not takes into account any other element. For example: Investment into convertible debenture with 4% interest rate would fetch an amount 4% more than the initial investment amount. Similarly if have taken loan at say 11% p.a, you would need to 11% more in comparison to the borrowed money as interest amount. Generally, interest rate is used to depict the macroeconomic scenario or the lending rate ( rate at which credit is being offered).

Yield: Yield from an investment indicates the return taking into consideration factors such as tax advantages. Yield is more precisely gains made from an investment and can be represented either in % or currency terms. Upon compounding of interest, yield from a given financial instrument increases. So, Rs. 10,000/- investment into some financial instrument for a 1 year with 4% rate of interest would generate an yield of Rs. 400.

Let's take an example: In a bank deposit interest rate is compounded quarterly. So, if you receive an interest rate of 10% per annum compounded quarterly, the bank will add the interest after 3 months to your principal and your yield will be higher. So, from the fourth month you will get interest of 10% per annum on your principal and the interest which pushes up your yield. Yields will always be higher than interest rates.

So, the faintest and perhaps the major difference in the two terms is that yield is the profit made on an investment while interest rate is the reason for the profit.


Read more about: interest rate, yield, bond, deposits, debt
Story first published: Tuesday, September 17, 2013, 10:13 [IST]
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