Fixed Income
Confusion between yield and rate of interest reflects financial illiteracy among business journalists

Confusion between yield and rate of interest reflects financial illiteracy among business journalists

 

There is an article in The Economic Times, Mumbai edition on corporate FDs titled, “Interest in Corporate FDs on the Rise Again” (ET, 10 May 2013). The article talks about growing popularity of corporate FDs (fixed deposits) among investors. The writer of this news item states, “Best-rated fixed deposits from Mahindra & Mahindra Finance offer 12.2% per annum and fixed deposits issued by Jaypee Group offer rates as high as 15.07% on a three-year FD on a cumulative basis. Against this, banks such as SBI (State Bank of India) offer 8.75% deposits of similar tenors and private banks like HDFC Bank offer anywhere between 8% and 8.75%”. This article shows how articles on deposits and investments need to be read with lots of attention. 
 
First and most importantly, M&M Finance does not offer 12.21% return as of now, so the article has a factual error. M&M Financial Services offers the following returns now:
 
 
interest rate, yield, financial illiteracy, business journalists, business writers, Corporate FDs, investors, bond market, coupon, bank fixed deposits
 
 
 
So the best yield offered now is 11.85% for 60 months deposits. However, the objective of this article is to show how financial illiteracy is even pervasive among business writers. In this particular ET article, the confusion between yield and rate on interest comes to the fore. Let us first look at M&M Financial Services advertisement which the ET article is supposedly referring to and which is attached below. The ET article uses the earlier rate offered by M&M which matches with 12.2% mentioned in the article. It is very clear from the advertisement that M&M was offering interest rates as 10 p.a. for 60 months (See data, cumulative deposit 60M) which translates into a yield of 12.21%. The yield shown in the advertisement is 12.21% which is equivalent to 10% rate of interest per annum. It is obvious that yield and rate of interest are different.
 
interest rate, yield, financial illiteracy, business journalists, business writers, Corporate FDs, investors, bond market, coupon, bank fixed deposits  
(Please note that this advertisement is being used just to show comparison. The rate offered by M&M finance has changed. Refer rate in the chart one above for current rate) 
 
SBI, on the other hand, offers 8.75% interest per annum on fixed deposit. There is obviously no mention of yield in these deposits (except for one deposit which is tax saving deposit). So is it fair to compare yield of M&M Financial Services yield with interest rate of SBI? The answer is a firm No. The difference in rate of interest is only 1% between a SBI deposit and M&M deposit for a five-year term, if the details given in the article are to be believed, which translates into difference of 100 basis points only.  A bank like Andhra Bank offers 9% on a five year fixed deposit which means the difference is only 0.75%. 
 
Ideally, the author should have converted rate of interest of bank deposits into yield and then compared it with M&M Financial Services and other corporate fixed deposits. Using the same logic as used by M&M, Andhra Bank’s deposit for five year gives a yield of 10.77% and a SBI deposit gives a yield of 10.45%. The difference on yield basis works out to be 108 basis points in case of Andhra Bank and 140 basis points in SBI. The article says that 200 to 300 basis points difference exists between corporate FD and bank deposit which is definitely not correct in case of M&M Financial Services deposits.  After all, apple to apple comparison is the fair way to compare financial products. 
 
In fact, the bond market is an unexplored area for many writers and there is large-scale lack of understanding on basic concepts like coupon, rate of interest, yield, etc.  Before making any investment decision based on such analysis, it is better to consult a financial advisor.
 
(Vivek Sharma—http://www.moneylife.in/author/vivek-sharma.html—has worked for 17 years in the stock market, debt market and banking. He is a post-graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.) 

 

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COMMENTS

Garcia Kenneth

4 years ago

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B Ramesh Adiga

4 years ago

There is one more dimension to the analysis. The M&M deposit of Rs.10000 for 60 months yields Rs.16289/- @ 10.25%, whereas the yield in a commercial bank under similar terms would be Rs.16,587/-. This is because the compounding frequency in M&M is yearly whereas it is quarterly in banks.

Naresh Nayak

4 years ago

Pardon me Vivek, the effective interest rate formula is incorrect

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.

Naresh Nayak

4 years ago

Hi Vivek,

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".

REPLY

vivek sharma

In Reply to Naresh Nayak 4 years ago

The crux of this article is the to show fair degree of comparison when two different parameters are used. Yield can be calculated in many different ways as you have mentioned but in the context here yield denotes the return that the customer gets if he holds an investment over a period of time.

Naresh Nayak

In Reply to vivek sharma 4 years ago

Hi Vivek,

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.

Aniruddha Sengupta

4 years ago

Well pointed out. Much of the financial communication directed at investors tends to carry inaccuracies which they can well do without. Much of it stems from the fact that there is a lack of focus to simplify the content or de-jargon-ise, if I may use the term. If I were to attempt to communicate the same - Yield (annualised) is the rate of return which an investor will get on an annual basis if he were to invest under the cumulative option (interest payable on maturity). The annual coupon is the nominal rate of interest payable at the indicated interval (time gap) multiplied by the frequency of such payments during a period of 12 months. This of course can be illustrated further with a numerical example. Further distinction can be brought in by changing the period of interest payment from quarterly to half-yearly to annual. Moneylife can further help by providing calculators online or links to online calculators.

Sanjay Matai

4 years ago

Sorry to say that while ET is wrong, the above write-up too is wrong. Interest rates cannot be converted into yield in the manner given (both in M&M's ads and in the article). Why?
The answer for the same is available at the following link:
http://www.moneycontrol.com/news/fixed-i...

REPLY

vivek sharma

In Reply to Sanjay Matai 4 years ago

Sanjay, I think you should start reading the note in every advertisement carefully and also start looking at advertisements properly. You have jumped to a conclusion too fast and gone wrong in the process. The first advertisement also has a note which indicates how the annualized yield has been arrived at. If you read note at the end of M and M ad, you will realize why you are wrong.( Please open the link of first ad).

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.

Sanjay Matai

In Reply to vivek sharma 4 years ago

I beg to differ. Howsoever explicit one may be, if the concept is misleading, it remains misleading. Just because there is explanation behind it, doesn't justify it and make it correct.

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.

Naresh Nayak

In Reply to Sanjay Matai 4 years ago

Sanjay, please use the correct nomenclature. Now what is annualised yield? Is it the Annual Effective Rate?

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.

pawan

In Reply to vivek sharma 4 years ago

Dear Vivek,
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.

vivek sharma

In Reply to pawan 4 years ago

Total cash return to the investor is 6105 as interest and 10000 as principal. The total amount translates into 16105. The total interest returned to a customer over a period of 5 years is 6105 which if annualised as amount is 1221 (6105/5) which translates into 12.21% per year return ( not compounded).

vivek sharma

In Reply to pawan 4 years ago

Please run the following formula in excel to get the calculation of effective yield in first case.

=((1+ (0.0975))^5-1)/5

This will come as 11.85%.

Jose Koshy

4 years ago

Well done Vivek. Am always amazed when such articles come out without much research or thought. Good we have Moneylife and journalists like you to bring it up and educate readers. Keep it up.

raj

4 years ago

Good catch Vivek. I did think something was wrong with ET article when I read it last week. 200-300 basis point difference between corporate FD and bank FD seemed unrealistic.

Cummins India’s guidance on the export business and sustainability of margins are key inputs for investors

Cummins India could recoup some of its lost ground on the back of a one-time gain of Rs491 million from sale of investments, says Nomura Equity Research in its First Look on the company’s stock

 
Cummins India reported weak quarterly results in the fourth quarter of FY13 on the back of a sharp fall in EBITDA margins (-236bps year-on-year and -193bps quarter-on-quarter), which resulted in EBITDA missing Nomura’s estimates by 17%. However, at the net profit level, the company could recoup some of its lost ground on the back of a one-time gain of Rs491 million from sale of investments. 
 
Nomura looks forward to Cummins India’s management’s guidance on the export business and sustainability of margins as key inputs for investors in the stock market. The company’s conference call on the subject is slated for 13 May 2013. Overall, Nomura thinks that the stock market would be more focused on improvement in conditions in the export and domestic businesses, which are likely to drive earnings growth on a more sustainable basis. 
 
Cummins India’s performance in FY13 is given in the table below (Rs million):
 
Cummins India, Nomura Equity Research, management guidance, exports, sale of investments, conference call.

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Income Tax dept slaps Rs557 crore notice on BPO firm WNS

The tax demands, which include taxes on income and services, are for financial years 2003 to 2010, WNS had said in its annual report for 2012-13 given to the US Securities Exchange Commission

 
After Vodafone, Nokia and Shell, WNS is the latest multinational company (MNC) that has come under the tax scanner on transfer pricing issue. The outsourcing major has received demands of additional tax of about Rs557 crore on income with regard to acquisition of UK-based Aviva’s BPO services.
 
The company, however, has challenged the income-tax notices in courts of law.
 
The tax demands, which include taxes on income and services, are for financial years 2003 to 2010, WNS had said in its annual report for 2012-13 given to the US Securities Exchange Commission.
 
Among India's leading pure-play BPO providers, WNS had a headcount of 25,520 as of March 2013. It has delivery centres across nine countries—Costa Rica, India, the Philippines, Poland, Romania, South Africa, Sri Lanka, the UK and the US.
 
“We may be required to pay additional taxes in connection with audits by the Indian tax authorities,” WNS said in its annual report. “These orders assess additional taxable income that could in the aggregate give rise to an estimated Rs282.73 crore ($52.1 million based on exchange rate on 31 March 2013) in additional taxes, including interest of Rs102.94 crore ($19.0 million). From time to time, we receive orders of assessment from Indian tax authorities assessing additional taxable income on us and/or our subsidiaries in connection with their review of our tax returns. We currently have orders of assessment for fiscal 2003 through fiscal 2010 pending before various appellate authorities.”
 
The company follows April-March financial year.
 
The assessment orders allege that transfer prices applied by WNS to certain global transactions between WNS Global, one of its Indian subsidiaries, and other wholly-owned subsidiaries were not on “arm’s length terms, disallow a tax holiday benefit claimed by us, deny the set-off of brought forward business losses and unabsorbed depreciation and disallow certain expenses claimed as tax deductible by WNS Global,” it added.
 
Transfer pricing deals with a technique where parent companies sell goods and services to subsidiary entities at an inflated price to deliberately reduce profits and tax liability.

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COMMENTS

dinesh doshi

4 years ago

I strongly feel that next to politicians and beureaucrats, the most corrupt community is doctors.Doctors directly or indirectly tell patients that if do not accept what I say, you are going to die. Patients generally consider doctors as friendly well wisher. But in many cases it is not so.Fear of death is the biggest fear and doctors cash on that fear.Only a doctor can testify whether doctor is wrong. And doctor will not do that

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