Actual annual return on a bond including compounding from periodic interest payments.
Effective Yield refers to the actual annual return an investor earns on a bond, taking into account the effect of compounding.
Unlike the nominal yield, which is based only on the bond’s stated interest rate (coupon), effective yield includes how often interest payments are made such as annually, semi-annually, or quarterly and reinvested.
The more frequently interest is paid and reinvested, the higher the effective yield will be.
It gives a more accurate picture of a bond’s return compared to simple interest calculations. Investors use effective yield to compare bonds with different payment frequencies. It is especially useful in assessing fixed-income securities, allowing better evaluation of true returns over time.
Example: A bond with a 6% annual coupon paid semi-annually may have an effective yield of ~6.09% due to compounding.
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