The effective yield of an investment refers to the rate of return that you would achieve if you reinvested the profits at the same interest rate as soon as you earned them. The effective yield is commonly used with bonds that make interest payments. For example, if a bond makes interest payments quarterly, the effective yield would measure the annual rate of return if you reinvested the quarterly interest payments at the same rate of return as the bond as soon as you received them so that the interest payments would begin accruing additional interest.
1. Divide the annual interest rate by 100 to find the annual interest rate as a decimal. For example, if you purchase a bond promising a 6 percent interest rate, divide 6 by 100 to get 0.06.
2. Divide the annual interest rate on the investment by the times per year interest is paid. In this example, if the bond pays interest quarterly, divide the interest rate of 0.06 by 4 to find the periodic rate on the investment equals 0.015.
3. Add 1 to the periodic interest rate on the investment. In this example, add 1 to 0.015 to get 1.015.
4. Raise the result to the power of the times interest is paid per year. In this example, since interest is paid quarterly, raise 1.015 to the 4th power to get 1.061363551.
5. Subtract 1 from the result to find the effective yield for the investment. Completing this example, subtract 1 from 1.061363551 to find the effective yield for the bond equals 0.061363551, or about 6.14 percent.
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