Yield Equivalence

Yield equivalence is a concept in finance that states that two investments with different cash flows can have the same value if they have the same yield. This is because the yield of an investment is a measure of its return, and two investments with the same yield will have the same return over time.

There are a few different ways to calculate yield equivalence. One way is to use the present value of the cash flows from each investment. The present value is the value of a future cash flow today, and it is calculated by discounting the cash flow by the appropriate interest rate. If the present values of the cash flows from two investments are equal, then the investments have the same yield.

Another way to calculate yield equivalence is to use the internal rate of return (IRR). The IRR is the interest rate that makes the present value of the cash flows from an investment equal to zero. If two investments have the same IRR, then they have the same yield.

Yield equivalence is a useful concept for comparing investments with different cash flows. It can help investors to identify investments that have the same return, even if they have different cash flow patterns.

Here are some examples of yield equivalence:

• A bond that pays $100 in interest each year and matures in 10 years has the same yield as a bond that pays $50 in interest each year and matures in 5 years, if the interest rates on both bonds are the same.
• A stock that pays a dividend of $1 per share each year and has a price of $10 has the same yield as a stock that pays a dividend of $2 per share each year and has a price of $20, if the dividend growth rate on both stocks is the same.

Yield equivalence is a powerful concept that can be used to compare investments with different cash flows. It can help investors to make informed decisions about where to invest their money.