Confusion between yield and rate of interest reflects financial illiteracy among business journalists
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it should read as
2. effective rate of interest = (1+ coupon interest rate in % per annum /no of units of time eg. no of quarters)^ total no of units of time e.g.. 10 quarters
The rate of interest per year after taking into account the compounding nature of the paid out interest into principal.
Addendum-
Coupons are derived from interest yielding paper instruments issued in the earlier years which carried postage stamp like detachments on the bond certificate which was the interest due to the bond holder. Each time the interest was due, the bond holder had to detach the coupons and give it to the bond issuer who would give the bond holder cash in exchange for the coupon. Coupon rate is the printed interest rate on the bond certificate.
I thought there are three things in a bond
1. Coupon or interest rate - the annual rupee interest divided by rupee principal * 100
2. effective rate of interest = (1+ coupon interest rate in % per unit of time e.g. quarterly /no of units of time eg. no of quarters)^ total no of units of time e.g.. 10 quarters
The rate of interest per year after taking into account the compounding nature of the paid out interest into principal.
3. yield (yield to maturity) - the coupon rate of a bond which is actively traded in the bond markets like a share. When the price of the traded bond changes in the bond market, the yield to maturity changes.
There is no concept of "effective yield" as is mentioned in the article. Yields are typically used in traded bonds hence the term "bond yields".
The concepts explained however, are of course correct. A useful example to add could be the traded bond.
Furthermore you are correct when you say the most dangerous people in the world are half knowledged financial journalists. I know of countless people who lost their hard earned salary money listening to these financial journalists. This is what caused the disclaimer to be put on all news channels and news papers "This is in no way investment advice and we are not licensed investment advisors".
There is concept called "effective yield". I just saw it on the internet. The nomenclature and jargons should be correct and used correctly. Without the use of correct names, the entire concept becomes nebulous and confusing which is what plagues most journalists/writers today. Kudos on the article.
The answer for the same is available at the following link:
http://www.moneycontrol.com/news/fixed-i...
The second advertisement of M and M appearing in blue, also gives amount on maturity, so the method of calculation of yield is very explicit. I understand that yield calculation is done as a practice using yield function in excel and also using APR formula. However, for your understanding I wish to ad that yield is the amount of cash that returns to the owner of security and can be expressed differently. It is fair to express yield in a particular way as long as methodology is explicit.
Most investors assume annualized yield as the effective returns per annum. This is a wrong perception which I tried to dispel through my article. Converting the maturity amount of a multi-year deposit into an annualized yield using 'Simple Interest' gives a misleading picture since the effect of compounding is ignored.
Ideally, you should have compared 9.75% p.a. interest on M&M deposit with the 9.04% effective annualized yield on SBI FD (8.75% interest payable on quarterly basis means that effective yield is 9.04%).
That is be the true 'yield' or 'interest' or 'returns' or whatever name anyone uses.
This annualised yield name is totally confusing to me. Please call it Annual Effective Rate if you must.
Also what does 'effective returns per annum' mean? That is another confusing jargon. There is no such thing as effective returns per annum.
The best way to explain is to use a formula since everybody has its own financial jargons except for the professional investors who carefully sift through the relevant jargon.
Effective returns per annum is plain and simple English (what you call as Annual Effective Rate).
To make different promises comparable, all numbers should be reduced to effective returns per annum i.e. how much returns will I earn per annum as if the payout was made once every year.
1. I could not find how the yield has been calculated by M&M in the first link as mentioned by you.
2. In this case, the annualised return which is shown as 10% by M&M correctly gives a cumulative value of 16105/- in 5 years but how this yield has been calculated by them and You is a mystery to me. if the compounding was happening monthly or quarterly or half yearly, then yield and annualised return would have been different. but in this case it is not so.
Which method you are talking is explicit is not clear to me.
As you are yourself saying that yield is a function of amount returned, if you calcuate 16105 over five years, it is 10% only on 10k investment.
I understand that through this article you are trying to make investors aware about how to rightly compare two instruments. Just that the methodology could have been correctly depicted. thanks for your time
=((1+ (0.0975))^5-1)/5
This will come as 11.85%.