Profitability is one of the key concepts in investment theory.The general principle of evaluating the effectiveness of any investment can be formulated as follows: "The higher the risk, the higher the yield."The investor seeks to maximize the yield of the securities portfolio that is in his possession, while minimizing the risks associated with ownership.Accordingly, in order to be able to use this statement in practice, the investor must have effective tools of the numerical assessment of both terms - and the risk-return investments.And if the risk, as a category of high-quality, very hard to formalize and quantify, the return, including the profitability of different types of securities can be estimated even a person does not have much luggage expertise.
Yield Securities inherently reflects the percentage change in the value of securities over time.Typically, the billing period is taken to determine the profitability of a calendar year, even if the time remaining before the end of the treatment of paper, less than a year.
theory distinguishes several types of investment returns.Previously widely used such a thing as the current yield securities.It is defined as the ratio of the sum of all payments received by the owner for a year due to possession of securities portfolio to market value of the asset.It is obvious that such an approach could only be applied to the shares on which the dividend payment is possible (that is, first of all preferred shares) and interest-bearing bonds, implying the payment of the coupon.Despite the seeming simplicity, this approach has one drawback: it does not take into account the cash flow that is generated (or may occur) due to the implementation in the secondary market or redemption by the issuer of the underlying asset.It is obvious that, as a rule, even a long-term nominal bonds is much greater than the sum of all coupon payments made on it during the entire period of its circulation.In addition, this approach is not applicable to such a popular financial instruments such as discount bonds.
All these deficiencies deprived another indicator of profitability - the yield to maturity.By the way, I must say that this figure is fixed in IAS 39 to calculate the fair value of debt securities.Following international standards, the same approach took over most of the national accounting systems of developed countries.
This rate is good because it takes into account not only the annual income from the income from the ownership of the asset, and the yield of the securities that the investor receives or loses due to the resulting discount or premium paid on the acquisition of a financial asset.And, when it comes to long-term investment, such discount or premium is amortized over the remaining term to maturity of the security.This approach is useful if you want to calculate, for example, the yield on government bonds, which in most cases are long-term.
When calculating the yield to maturity the investor should determine for itself such an important parameter as the required rate of return.The required rate of return - a rate on capital, which, from the point of view of the investor is able to compensate for it all the risks associated with investing in such assets.Accordingly, it is this figure determines whether the rate of the bond is traded on the market at a price above or below face value.For example, if the required rate of return above the annual coupon rate, the difference is the investor will seek to compensate for the expense of the discount on the nominal value of the bonds.Conversely, if the required rate of return lower than the annual coupon rate, the investor would be willing to pay the seller or issuer of bonds amount exceeding the nominal value of the securities.
