What is Yield?
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Type of Scenarios and Instruments Under which Yield Occurs
1. On Stocks
The yield that is earned on the stock is also known as the dividend yield. It can be computed by dividing the dividend paid to the stockholders by the current stock price. The formula is given as:
2. Yield to Maturity
It is used to calculate the total return expected each year if the bond is to be held till maturity and is generally the average yield expected each year. It is expected to remain constant until the maturity period.
3. Yield to Worst
It is the lowest possible yield that can be expected to be received on a bond. It acts as a risk measure and helps in ensuring that even in the worst-case scenario, the holder of the bond will receive a certain amount of returns on his investment.
4. Yield to Call
It is a special category of bond which is known as the callable bond, wherein the issuer of it can redeem the bond before its maturity is over and generally refers to the yield wherein bond pays at the time of its call date.
What is Capital Gain?
The capital gain refers to an increase in the value of a capital asset and the amount that is realized when the asset is sold off. A capital gain may be short-term or long-term depending on the tenure for which the asset is held. A capital loss generally occurs when the market value of an asset decreases over a while as compared to its purchase price.
What is Capital Gains Yield (CGY)?
The capital gains yield (CGY) can be described as the percentage rise in the price of common stock or other security or capital asset. Capital gains yield is generally ascertained by dividing the rise in the price of a stock by its original price. In case if the investment in securities generates no cash flow, the capital gains yield is equal to the amount of return. If the stock price increases in value, then there is a capital gain, however, if there is a decrease in the price of stock then it is considered as a capital loss.
The capital gains yield is unpredictable and if the price of a stock falls below its original price no capital gains yield can be generated. The percentage of CGY which is arrived at by using a calculator is generally kept to two places after the decimal point as a practice. The use of a calculator makes calculating decimal places less cumbersome. The dividend that is paid to the stockholder is not considered in the capital gain as it is already given to the stockholders.
Some stocks pay low dividends but produce higher capital gains because the company does not distribute them to the shareholders and instead reinvests them back for its growth. On the other hand, some stocks pay very high dividends but produce very low capital gains because the amount that is paid out as dividends cannot be reinvested in the company.
The formula for the computation of the capital gain yield:
Where CGY = Capital Gain Yield
P1 = Current or Selling Price of the Stock
P0 = Previous or Purchase Price of the Stock
For example, Sam bought stocks in a retail company two years ago and paid $73 per share. The current market price of the share is now down to $47 and Sam expects further decline because online shopping is amending the way customers buy products. Calculate his capital gains yield?
In the above case, as the stock price has declined, Sam has a negative CGY.
The CGY generally uses the rate of change formula. The calculation of CGY effectively calculates the rate of change in the stock prices. The rate of change can be deduced by subtracting the current market price of a stock from the original amount then dividing the resultant by the original amount of stock. The CGY calculator is normally used to arrive at a percentage of CGY.
The calculator contains two fields namely: Initial Stock Price and Current Stock Price, which when populated with figures, gives us the percentage of CGY. The CGY calculator makes it very easy without having to do any sort of calculations. The calculator also makes it easier to compute the CGY appropriately and effectively when there are large chunks of data available.
Difference Between Capital Gains Yield and Dividend Income
The CGY is usually a profit that an investor earns when his investment is sold at a price that is higher than the original price, while the dividend is paid out to the shareholders out of the profits of a company.
The tax rates in the case of capital gains depend on the factor, whether the investment in the asset was for a short-term or a long-term period. However, in the case of dividend income, the tax rates are based on whether the dividends are ordinary or qualified. The qualified dividend holders are mostly eligible to pay capital gains tax at lower rates.
The distribution of dividend income depends on the decision of senior management, while CGY is dependent on the market situation. In the case of dividend income, less investment is required to purchase stocks, on the other hand very high investment is required to generate a large CGY.
Context and Application
The topic CGY is generally used in professional exams like
- Bachelors of Commerce (B.Com.)
- Bachelors of Commerce (Honours) or B.Com. (Hons).
- Bachelors in Economics.
- Bachelors of Business Administration (BBA).
- Bachelor of Management Studies (BMS).
- Chartered Accountancy (CA).
- Company Secretary (CS).
- Cost and Management Accountant (CMA)
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