Required Yield - Explained
What is a Required Yield?
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Table of ContentsWhat is a Required Yield?How Does a Required Yield Work?
What is a Required Yield?
Required yield refers to the amount of return investment or financial instrument that must accrue to it to be regarded as a profitable and attractive investment. Required yield is often used for bonds, it describes the minimum return a bond must offer before the investment can be considered worthwhile by a potential investor. Investors often consider the required yield of a bond before making investment decisions. The market forces determine the required yield of a bond and how new issues will be priced in the market.
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How Does a Required Yield Work?
Investors, whether individuals or institutional investors look at the required yield of a bond or financial instrument to know whether it is an attractive and profitable investment option or otherwise. Investors describe required yield as the compensation they receive for the level of risk they undertake in an investment, it is the minimum rate of returns that investors expect from an investment. The level of risk an investor undertakes in an investment determines the required yield for that investment. Usually, the lower the risk, the lower the required yield and vice versa. Also, interest rate son bonds play a vital role in how high or low the yield would be. Buyers and sellers agree to the interest rate of bonds depending on the premium paid for the bond and the bonds coupon. Investors determine and differentiate good investments from bad ones through the yield, the required yield is compared with the yield to maturity (YTM) of the investment to decide whether it is appealing or otherwise. The yield to maturity of an investment refers to the entire earnings of the investment from the time it was purchased until when it matures. Also, the present value of a bond can be determined using its required yield. This means the required yield will be used in discounting the cash flows of the bonds to realize its present value.