By Danielle Smyth Updated September 17, 2020
When it comes to finance, some terms may seem interchangeable, but it’s important to understand the differences between very similar concepts. In most cases, when looking at investments, one evaluates the percentage of their initial investment that they might earn back over a period of time, and how that compares to other uses of this money. Interest rates and yield are similar concepts, but exist on opposite sides of the investment spectrum. Understanding the difference between yield and interest rate is essential for businesses.
Yield vs. Interest Rate
Interest rates are the fees charged, as a percentage of the magnitude, from a lender for a loan. As explained by Fidelity, when loaning money, an institution charges interest, since the value of money today is different than the value of money in five years; the percentage they choose to represent this changing value is their interest rate. Interest can also control the rate of return on some of the more stable investments, like a CD or a bond; the rate the loaning entity charges can change based on the market.
Yield is the percentage of earnings a person receives for lending money. An interest rate represents money borrowed; yield represents money lent. The investor earns interest and dividends for putting their money into a certain investment, and what they make back upon that investment is the yield. It’s also expressed as a percentage.
So while interest rates and yield are tied to each other, Compass Credit Union explains that the terms apply to two completely different situations. You might wonder, what's the difference between yield and return? Interest rates are relevant when considering taking a loan from a lending entity; yield is relevant when considering doing the actual lending. They are, of course, related; yield for any loan needs to be comparable to a general investment interest rate, because the overall transaction needs to be profitable on both sides.
Sample Interest Rates and Yield
For example: A bank customer takes out a loan of $1,000 to purchase a computer. The bank’s interest rate is 10 percent annually. This means that, after a year, the customer will owe the bank $1,000 + ($1,000 x 10%) = $1,000 + $100 = $1,100. The customer pays this back at the set interest rate.
The initial yield for the bank is the $100 they have obtained with the $1,000 they loaned. However, if this transaction cost them $5 in bookkeeping and $15 in hours worked managing this loan, the actual yield is $100 - $20 = $80.
So the yield and interest rate are related; the yield will at best be equal to the interest rate, providing a return at the same percentage point the borrower is willing to pay. In reality, however, yield percent can be lower than interest rate, because the loaner may incur additional costs in managing the loan.
Making Related Business Decisions
For a business looking at the market to determine options, it’s important to understand the rates and how they interact. If a company feels that it can generate more value by investing money into a higher-yield opportunity, they may do so, but that means the money is tied up in an external investment, rather than acting as a reinvestment into the company.
Likewise, if the company feels like interest rates are low enough, they may decide to borrow money to invest into the company, and take the risk of seeing what sort of yield will emerge from a capital investment.
FAQs
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.
What is the difference between yield and interest rates? ›
Comparing Yield and Interest Rate:
Yield represents the total earnings from an investment, including interest. Interest rate is the percentage of the amount borrowed or paid, over a principal amount. Yield typically includes the amount of interest earned.
Are Treasury yields and interest rates the same? ›
Treasury prices and yields tend to move in opposite directions and are affected by supply and demand and the health of the economy. The purchase price or face value of a Treasury note is what you pay to buy it. The T-note's yield is the interest rate you earn for loaning the government money.
What is the difference between interest rate and annual percentage yield? ›
Both are expressed as percentages. The key difference between APY and interest rate is compound interest. APY includes interest that's earned on the original balance as well as the amount of compound interest earned in one year. Interest rate only accounts for interest earned on the original amount.
What is the difference between interest rate and yield on a CD? ›
The interest rate is used to determine how much interest the CD earns each day. The Annual Percentage Yield (APY) is the effective annual rate of return based upon the interest rate and includes the effect of compounding interest.
Why do yields go up when interest rates go up? ›
When the Fed increases the federal funds rate, the price of existing fixed-rate bonds decreases and the yields on new fixed-rate bonds increases. The opposite happens when interest rates go down: existing fixed-rate bond prices go up and new fixed-rate bond yields decline.
Does high-yield mean high interest? ›
Key Takeaways. High-yield bonds, or junk bonds, are corporate debt securities that pay higher interest rates than investment-grade bonds. High-yield bonds tend to have lower credit ratings of below BBB- from Standard & Poor's and Fitch, or below Baa3 from Moody's.
Should I buy bonds when interest rates are high? ›
Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.
How much is a $100 savings bond worth after 30 years? ›
How to get the most value from your savings bonds
| Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
|---|
| $50 Bond | $100 | $207.36 |
| $100 Bond | $200 | $414.72 |
| $500 Bond | $400 | $1,036.80 |
| $1,000 Bond | $800 | $2,073.60 |
May 7, 2024
The higher the yields on long-term U.S. Treasuries, the more confidence investors have in the economic outlook. But high long-term yields can also be a signal of rising inflation expectations.
For example, $1,000 put into an account with an annual interest rate of 5% would, in theory, earn $50 at the end of the year. However, if the rate is 5% with interest earned monthly, the APY would actually be 5.116%, earning you $1051.16 by the end of the first year.
What does 5.00% APY mean? ›
A 5% APY means your money earns 5% interest per year. If you deposited $100 in an account that compounds annually, you'd have $105 at the end of a year. But accounts may compound monthly, weekly, daily or even continuously. The more frequent the compounding periods, the more interest you earn.
What is a good annual percentage yield? ›
For example: The checking accounts with the highest yields pay up to 3 percent APY, while other checking accounts pay nominal to zero interest. The national average for a savings account is only 0.58 percent APY as of May. 28, 2024, but the best online savings accounts pay at least 5 percent APY.
What is the difference between yield and interest rate? ›
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.
How much will a $500 CD make in 5 years? ›
This CD will earn $117.15 on $500 over five years, which means your deposit will grow by 23.4%.
Can you lose money in a high yield CD? ›
Once your CD matures, you'll get your original investment back plus the interest accrued. Unlike stocks or cryptocurrencies, which present a risk of loss, CDs are generally considered safe investment vehicles that do not lose money.
Is effective yield the same as interest rate? ›
The interest rate refers to the percentage charged or earned on a principal amount, while the effective annual yield represents the actual annual return on investment, considering compounding.
What is the relationship between interest rate and yield to maturity? ›
The YTM is a snapshot of the return on a bond because coupon payments cannot always be reinvested at the same interest rate. As interest rates rise, the YTM will increase; as interest rates fall, the YTM will decrease.
Is yield the same as interest rate in fixed deposit? ›
Understanding the difference: FD yield vs interest rate
The interest rate refers to the percentage at which your FD earns interest over its tenure. On the other hand, the annualised yield takes into account not only the interest rate but also factors such as compounding frequency and investment duration.
How do yields affect mortgage rates? ›
Factors that influence mortgage rates
Fixed-rate mortgages are tied to the 10-year Treasury yield. When that goes up or down, fixed-rate mortgage rates follow suit. The fixed mortgage rate isn't exactly the same as the 10-year yield, however; there's a gap between the two.
