The Annual Percentage
Yield (APY) also known as the Nominal Interest Rate, Annual Interest Rate or
Annual Percentage Rate (APR) can simply be defined as the actual annual
rate of return taking into consideration the compounding interest over the
period of time. Mathematically APY can be computed via the mathematical formula
BREAKING DOWN ‘Annual Percentage Yield – APY’
When considering loans instead of investment, total
borrowing cost including fees as a single percentage number then the APY is
analogous in nature to the Annual Percentage Rate (APR). Both are synonymously
used a consistent measures for the interest rates, nonetheless contrasting to
the APR equation, the equation for APY does not contemplate account fees, it only
contemplates on the compounding periods. Its effectiveness also lies in its
ability to normalise changeable interest-rate agreements into an annualized
APY vs. Rate of Return
In an investment situation, when an investment grows over a specific
period of time the scenario is considered as the rate of return. This can be
expressed by way of percentage of the real investment amount inputted from the
original start off.
Rates of return can be difficult to compare across different investment
vehicles, especially when such vehicles feature different compounding periods.
For case in point, one investment can compounds its interest monthly, while
another compounds can quarterly, or even another compound can yield biannually
and lastly, some compounds interest rate can only once per annum.
Comparing these margins by simply redefining each value per year
yields inaccurate results, as it ignores the effects of interest rates fills.
The shorter the integration period, the faster the investment is, since the end
of each combined period, the interest earned in the period is added to the
principal, and future interest is charged to the principal.
example, if you are considering whether to invest year bond year coupon payment
of a 6% market when due or paid income to pay 0.5% monthly interest rate of
At first glance, it seems the output equal to 12 months
multiplied by 0.5% equals 6%. However, when the effect of the compound is
calculated by calculating the APY, the second investment actually brings
6% divided by 365, at a cumulative daily interest, which has a higher APY. This
is because the basic balance where the interest rate increases daily, instead
of once a month or once a year.